From the October 01, 2012 issue of Futures Magazine • Subscribe!

Exploiting crack spreads with options

Exploiting with options

The close proximity of the curves on “Energy call options” suggests some potentially profitable spread possibilities. For example, Valero and Tesoro stock prices are similar in volatility, as are the prices of gasoline and heating oil futures.

On “Heating oil/gasoline spread” (below), the difference between the two December 2012 futures prices varies from 32¢ to 41¢ per gallon, or $3,780 for 0.09 of one option point valued at $42,000. This is the maximum spread over the period shown, but there would have been other opportunities including two moves of 6¢, approximately $2,520 each way, starting at April 13 and May 25. This spread often is called “the widow maker.”

The “Cumulative percentage changes” chart shows that all of the associated crack spread variables tend to move together over extended periods, so that watching for shifts in pricing can focus on short-term seasonal — primarily weather-related — influences together with market and geopolitical influences. Currently, heating oil is following its typical seasonal movement, generally falling from January to June, then rising from July through November. This trend has a positive impact on energy-related equities.

Forecasting crack spreads is possible by using the upper and lower breakeven prices computed by the option pricing regression model, LLP (available at as a free Excel download worksheet). Breakeven prices show the upper and lower futures price at expiration that would permit an initial delta spread (long the number of call options specified by the slope, or delta, of the option price curve while selling short one underlying futures contract) to be free of profit or loss at expiration. 

On June 26, 2012, the following breakeven prices existed for December 2012 futures:

  Futures Strike Upper Lower
Heating oil 2.5976 2.70 3.040 2.307
Gasoline RBOB 2.2438 2.30 2.585 1.825
Crude oil 81.04 86.00 101.914 73.197

With December futures prices current as of mid-July, the energy crack spread forecast is 18.119. The upper breakeven spread is 13.028, and the lower spread is 10.201. The forecast is biased to the low side by the crude oil upper breakeven price having a greater percentage gain over the current price than either heating oil or gasoline. 

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