CRACK SPREAD TRADING
Overview
Trade the refining margin — the price difference between crude oil (input) and refined products like gasoline and heating oil (outputs). The crack spread reflects refinery profitability. When refiners are highly profitable, cracks tend to revert; when margins are thin, they expand.
Setup
- 1.Calculate the standard 3-2-1 crack spread: (2 × gasoline + 1 × heating oil) - 3 × crude oil, all in $/barrel.
- 2.Monitor refinery utilization rates (EIA data) — low utilization widens cracks; high utilization narrows them.
- 3.Track seasonal demand: gasoline cracks peak May-July (driving season); heating oil peaks November-February.
- 4.Enter crack spread via NYMEX (buy RB + HO futures vs. short CL) or use ETFs as a proxy.
- 5.Use crack spread as a hedge if you hold refining sector stocks (MPC, PSX, VLO).
Max profit
Spread returning to historical norms — 3-2-1 crack spreads typically range $15-45/barrel.
Max loss
Spreads can remain distorted for extended periods during supply chain disruptions. Use time-based stops.
Breakeven
Entry spread value plus transaction costs.
When to use
During extreme spread dislocations (COVID demand crash, hurricane damage to Gulf refineries, sudden crude surplus). When fundamental catalysts create temporary divergence from historical norms.
When to avoid
When structural changes are occurring (permanent refinery closures, long-term demand shifts from EVs). Don't mistake a new regime for a temporary dislocation.