Subject: Derivatives - Futures Crack Spreads

Last-Revised: 1995
Contributed-By: Richard Hiatt
Originally in the misc.invest.futures FAQ by Dave Hein and Richard Hiatt. Reprinted by permission.

A crack spread is the difference between crude oil, gasoline, and heating oil prices. Refiners produce or buy crude oil and sell the petroleum products. The crack spread defines the value added by the refining operation. In analysis of the spread there are 3 standard spreads to work from. The 5-3-2 spread reflects 5 barrels of crude to produce 3 barrels of gasoline and 2 barrels of heating oil. The other standard spreads are the 3-2-1 (3 bbl crude vs. 2 gasoline and 1 heating oil), and 2-1-1 (2 bbl crude, 1 gasoline, 1 heating oil).

To calculate the spread you first translate the crude oil price into cents per gallon. A price of $17.12 per bbl of crude works out to .4076 per gallon (17.19/42). So for example the 5-3-2 spread:

   ( 3 gas + 2 HO)  -  5 (crude/42)
---------------------------------------------
                       5

(3 x gas =) 1.4790 (Crude Oil/42 =) .407619 (2 x HO =) + 0.9854 x 5 ------------ ----------- 2.4644 2.038095 (Product) 2.4644 (Crude) - 2.0380 --------------- = .4263 --------------- = .0853 5

Past data has shown that spreads in the mid to low 8-cent area were good buy-spread points. On the '94 contracts spreads in the .0750 to .0800 area were the extreme. So to buy the spread, you sell the crude and buy the products. To sell the spread, you buy the crude and sell the products.

The most frequently asked question is, "how does the spread work out in dollars?" For this we'll go to 09/19/95 prices where we have 100-point moves in the spreads. On 09/19/95 the spreads on Dec. 95 contracts were as folows: the 3-2-1 was 0.0964, the 2-1-1 was 0.0960, and the 5-3-2 was 0.0962. Prices on the December contracts were as follows: Crude was 18.08, heating oil was 0.5255, and gasoline was 0.5275.

A sell of the spreads on 9/19 and buy on 10/10 would have this result in dollars. First the 3-2-1 spread:

    buy  3 Dec. Crude @ 18.08 . Close (sell)@ 17.12 = 288 points = $(2,880.0)

    sell 2 Dec. Gas   @ .5275   Close   @ .4930 = 345 points = 2,898.0

    sell 1 Dec. Heating @ .5255 Close  @ .4927  = 328 points = 1,377.6

    Net is $1,395.

Next the 2-1-1 spread:

    buy  2 Dec. Crude and close for 192 points = $(1,920.00)

    sell 1 Gasoline & close for 345 points     =   1,449.00

    sell 1 Heating Oil & close for 328  points =   1,377.60

    Net is   $   906.60.

Finally the 5-3-2 crack spread:

    The long  crude profits =  $(4,800.00)

           short Gasoline =    4,347.00

           short Heating  =    2,755.20

    Net is  $ 2,302.20.

So based on this time frame the spreads work out as this per point:
    3-2-1 = $ 12.57 per point

    2-1-1 = $  8.39 per point

    5-3-1 = $ 21.12 per point

Costs will vary according to crude type, and seasonal demands for the end product will have some effect on the spread. On average 1 barrel of crude yields 50 to 55% gasoline 20%-25% heating oil. What's left is asphalt on the heavy end and butane on the light.

Some traders like trading the crude with one month forward on the product contracts to factor in the storage. In addition to the crack spread (refining spread), traders can and do trade the 1-1 crude to gas or crude to heating oil. Most firms have considerably lower margin costs for spreads.

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