Crack Spread: Crude Oil, Heating Oil, Gasoline

Another popular intercommodity spread is the crack spread. This spread shows the interrelationship between heating oil, gasoline, and crude oil. In identical fashion to the soybean crush spread, oil refiners attempt to hedge their risk from crude oil prices and its refined products. The most popular ratio is the 3:2:1 ratio: three crude oil futures contracts to two unleaded gasoline futures contracts to one heating oil futures contract.

The oil is bought in the front month and its by-products are sold in the following month or vice versa. In 1994 the New York Mercantile Exchange (NYMEX) made the crack spread convenient for all traders by considering this spread as one purchase, similar to the CBOT option. With oil shortages being predicted for decades to come this is a simple and inexpensive way for speculators to trade oil futures with a margin value that doesn’t exceed $10,000.

Gold-Silver Ratio Spread

Finally, there is the gold-silver ratio spread. This spread has long been used to determine how expensive or inexpensive gold is at any given time. The theory follows that if it takes more ounces of silver to purchase gold than it did previously, then gold is considered expensive. If it takes less silver to purchase gold, again regardless of the price, then gold is inexpensive. By playing around with this relationship, a trader can buy or sell gold and silver in the hope that they can profit from sudden increases or drops in value of both these precious metals.

Silver bugs believe that the prices of silver and gold should naturally revert to their historic interrelated monetary ratio of 16:1. As the prices wrestle for position there is a belief either that now is a good time to short gold and buy silver or that silver can increase in value to bring the ratio back in alignment. Whatever the case there is a constant hope that the prices will revert back to the mean to recreate this historic relationship. With this hope in place, whenever gold is stronger than silver there is a short gold, buy silver bias.

Whether you believe in trading the gold/silver ratio spread or not, others do. As a result, it is important to understand the psychology of those around you so you can better recognize opportunities in the precious metal sector for yourself.
Primary Drawbacks

Spread trading can be tricky. While you are given cheaper margins because the trades, on the surface, appear lower risk, don’t let down your guard. These trades are meant to be treated with the same respect as any naked position out there. Using options as a stop loss or putting stops in place to protect yourself is required. There are no shortcuts when using spread trading.


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