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Commodity-Product Spread

Commodity-Product Spread

What Is a Commodity-Product Spread?

The commodity-product spread is the difference between the price of a raw material commodity and the price of a completed product made from that commodity. The commodity-product spread forms the basis of a few most loved trades in the futures market.

To trade on the spread, an investor commonly consolidates a long position in raw materials with a short position in a completed product connected with the raw material.

Understanding a Commodity-Product Spread

Commodity-product spreads are a type of exotic option. The trader will sell futures in the raw commodity and simultaneously buy futures in the completed product produced using that commodity. Spread traders may likewise take the contrary side and purchase raw futures as they sell completed futures. These types of spreads are every now and again found in the oil and agriculture industries.

While exotic options can help offset risk in a portfolio, a few exotic options have increased costs in view of their additional elements. Moreover, the price moves for exotics can be vastly different than traditional options.

Types of Commodity-Product Spreads

The Crack Spread

The crack spread is the difference between a barrel of crude oil and the petroleum products extracted from it. Cracking is an industry term that alludes to the interaction purifiers use for splitting separated crude oil into completed products. This incorporates gases like propane, gasoline, heating fuel, light distillates, intermediate distillates, and heavy distillates.

The Crush Spread

A crush spread is utilized to hedge the margin between soybean futures and soybean oil and feast futures. With this strategy, a trader takes a long position on soybean futures and a short position on soybean oil and dinner futures. The trader may likewise take the contrary side of this options spread.

The Spark Spread

The spark spread involves natural gas as the raw material part and electricity as the completed product. Spark spread alludes to a calculation utilized by utility companies to estimate the profitability of natural gas-terminated electric generators. As a trading strategy, investors can utilize over-the-counter trading in electricity contracts to profit from changes in the spark spread. For coal, the difference is called the dim spread.

Special Considerations

In all cases, taking a long position in the raw material against a short position in the completed product yields a return that suggests the profit margin of the entity doing the processing.

For corporations that produce completed goods, contracts in light of the commodity-product spread act as a hedge against price volatility on the two finishes of the manufacturing cycle. This hedging assists with shielding a company's profits from rising costs on the off chance that raw material prices rise or on the other hand assuming that prices for completed goods fall.

Speculative Commodity-Product Spreads

Speculative trades in view of the commodity-product spread likewise exist. Speculators profit when the difference between the prices in the trade expands. Note that a risky trade could likewise include switching the long and short legs of the spread contingent upon which heading the trader anticipates that a price differential should go.

A speculator taking a gander at the oil and gas market would take a comparative position in the event that they accepted crack spreads were probably going to broaden. Since the speculator has no actual commodities to buy or sell, the aftereffect of the trade would be pure profit or loss, contingent upon whether the spread augmented or limited.

For instance, assume an oil purifier chooses to hedge its profits against changes in gas prices. The refinery takes a short position in petroleum products and a long position in oil futures. Along these lines, any loss in the purifier's margin from a fall in gasoline prices ought to be offset by a gain in the hedge position.

Nonetheless, assuming the price of gasoline were to rise, the profitable refining margin would be offset by an unprofitable trade. This type of hedging activity locks in a certain level of profit by involving changes in the spread to offset changes to the purifier's main concern.

Features

  • Traders in the futures market can utilize the commodity-product spread as the basis for various trading strategies.
  • On the other hand, traders can take the contrary side and purchase raw commodity futures while selling completed futures.
  • A commodity-product spread is the price difference between a raw material commodity and the price of a completed product produced using that commodity.
  • Normally, traders will make the spread by selling futures in the raw commodity while at the same time buying futures in the completed product produced using the commodity.
  • Three types of commodity-product spread strategies are the crack spread, the crush spread, and the spark spread.