A commodity-product spread refers to the price difference between a raw material commodity and the price of a finished product that is derived from that commodity. This spread plays a significant role in various trading strategies within the futures market. Traders often engage in these strategies by combining a long position in raw materials with a short position in the finished product associated with the raw material.
There are several types of commodity-product spread strategies that traders commonly employ. Three notable examples are the crack spread, the crush spread, and the spark spread. In the oil industry, the spread related to production and refining is known as the crack spread. This term originates from the process of refining crude oil, which involves "cracking" the carbon chains present in the oil. For instance, a 3-2-1 crack spread assumes that three barrels of crude oil will yield two barrels of gasoline and one barrel of distillate fuel. By using the prices of these three components, traders can calculate the average spread per barrel, which can serve as an index for trading purposes.
Similarly, in the soybean industry, the commodity-product spread is referred to as the crush spread. It represents the price difference between soybeans and the products derived from them, such as soybean meal and soybean oil. The crush spread is widely used by traders to estimate production costs and profit margins in the soybean processing industry. By analyzing the spread, market participants can gain insights into the profitability of crushing soybeans to produce meals and oil.
To execute a commodity-product spread strategy, traders can take two approaches. Firstly, they can sell futures contracts for the raw commodity while simultaneously buying futures contracts for the finished product. This approach allows traders to profit from the price difference between the two. Alternatively, traders can take the opposite side of the spread by purchasing futures contracts for the raw commodity and selling futures contracts for the finished product. This approach is suitable when traders anticipate a decrease in the spread.
Futures exchanges often offer pre-packaged long/short futures strategies that focus on commodity-product spreads. These strategies enable traders to engage in spread trading with one leg based on the raw commodity price and one or two legs based on the price(s) of the product(s) derived from it. The positions in these strategies are sometimes bundled together, resulting in a single aggregate margin calculation.
The commodity-product spread provides valuable information about production costs and profit margins in various industries. It helps traders and market participants assess the economic viability of producing finished goods from raw materials. By closely monitoring commodity-product spreads, traders can identify potential arbitrage opportunities and make informed trading decisions. Additionally, the spread serves as an indicator of supply and demand dynamics in the market, providing insights into the overall health of specific industries.
The commodity-product spread represents the price difference between a raw material commodity and the finished product created from that commodity. It serves as a key component of various trading strategies in the futures market. Traders can utilize commodity-product spreads such as the crack spread, crush spread, and spark spread to estimate production costs, profit margins, and overall industry health. By understanding and analyzing these spreads, traders can identify trading opportunities and make informed decisions within the complex world of commodity trading.
Summary:
The commodity-product spread is the difference between the price of a commodity and the price of the products at the next level of consumption which is made from the commodity.
In the oil industry, this is known as the crack spread, in the soybean industry, it is known as the crush spread. Some pre-packaged long/short futures strategies that trade on this spread are offered on futures exchanges.
The commodity-products spread is the difference in prices between a raw material and a product made from it, such as raw crude and gasoline. This difference gives a rough estimate of production costs and profit margin.
Traders can buy and sell futures in a strategy with one leg on the price of the raw commodity and one or two legs on the price(s) of product(s) created from it, and these positions are sometimes sold as a package with one aggregate margin calculation.
In the oil industry, the spread for production/refining is known as the crack spread because the process of refining involves “cracking” the carbon chains in the crude oil. A 3-2-1 crack spread is a ratio spread that assumes 3 barrels of crude will produce 2 barrels of gasoline and 1 barrel of distillate fuel.
Using the prices of the those three to compute the average spread per barrel can serve as an index.