Multi Leg Part III - Crack Spread

Crude Oil Crack

This article is the third in our series covering multi leg complex spreads fundamentals. Previous two articles focused on intra commodity spreads and inter commodity Crush spreads

In the petroleum industry, refineries are most concerned about hedging the difference between their input costs and output prices. Their profits are tied directly to the spread between the price of crude oil and the prices of refined products, gasoline and distillates (diesel and jet fuel). This spread is called Crack spread. It is referenced as Crack spread because of the refining process that “cracks” crude oil into its major refined products.

Refineries, like other processors, are caught between two markets. Raw materials they need to purchase and the finished products they offer for sale. The prices are often independently subject to variables of supply, demand, production economics, environmental regulations and other factors. Therefore refineries can be at enormous risk when the price of crude oil rises while the prices of the refined products remain stable or even decline. Such a situation can severely narrow the crack spread, which represents the profit margin. Because refiners are on both sides of the market at once, their exposure to market risk can be greater than that incurred by companies who simply sell crude oil, or sell products to the wholesale and retail markets.

In a typical refinery, gasoline output is approximately double of distillate fuel oil (the cut of the barrel that contains diesel and jet fuel). This refining ratio translates to 3:2:1 Crack spreads - three crude oil (CL) contracts versus two gasoline (RB) contracts and one heating oil (HO) contract.

Crack spread calculation needs conversion, because the quantities are given in different units. Crude oil is quoted in dollars per barrel, but gasoline and heating oil are both quoted in dollars per gallon and must be multiplied by 42 gallons per barrel to convert to dollars per barrel. Together with 3:2:1 ratio, we can define gross cracking margin (GCM):

GMC = -3*CL+2*RB*42+HO*42

Rationale behind the speculation on Crack spread is again very similar as on the other processing margin spreads. Going short Crack spread is called synthetic refining, transaction hedges an actual operating refinery. On the other hand, reverse Crack spread replicates a theoretical refinery.

The combined value of gasoline and heating oil must cover crude oil price and refining production costs. Crack spread can be affected by the seasons. For example, during the summer months, gasoline is in greater demand than heating oil. During the winter months, the demand will move to heating oil. If spread is too narrow to make a refining profit, we can expect that product prices should rise to meet crude oil prices and so we can favor heating oil and gasoline contracts over crude oil. On the other hand, if spread between product and crude prices is large, we can expect refineries will push production and selling of unleaded gasoline and heating oil to take advantage of the profit. This selloff should push product prices lower and we can favor the crude oil over heating oil and gasoline.


Let’s end up with summary of pros and cons of multi leg spreads.


  • Much more opportunities of profit than the outright futures position. Intra commodity spreads allow you to speculate on mean reverting tendencies or to take directional approach. Inter commodity spreads allows you to profit on commercial hedgers strategies.
  • Seasonality driven by strong fundamentals.
  • Exchange recognized multi leg spreads enjoy lower margin requirement therefore are increasing your ROI.


  • More legs take up more commission and bid/ask spread is wider.
  • Some brokers may not support complex spreads and you have to leg in and out of spreads.
  • Spreads with longer term contracts can have small volume and low liquidity.
  • Analysis of term structure changes or processing margin calculation can be much more complex than analysis of price changes of the outright trades.
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