The energy market is among the most watched and most quoted market in the world. It has geopolitical implications, it’s a critical manufacturing input for most goods and it tends to drive inflation via either raw crude prices or from its refined energy products suite. (gasoline, heating oil etc.)
Directional trading by speculators in oil markets happens of course, but given the market structure, the Whales deal in spread trading.
Spread trading is the simultaneous purchase of one security and sale of a related security, called legs. Energy trading’s most popular spread strategy is the Crack spread.
The Crack Spread
This spread focuses on the difference between crude oil prices and the prices of refined products like gasoline and heating oil.
The 3-2-1 crack spread is the most quoted. It represents the hypothetical profit margin a refinery earns from its raw crude converted to refined products.
It assumes from every three barrels of crude oil, a refinery produces two barrels of gasoline and one barrel of diesel fuel (You can’t magically turn all of it into gasoline due to degradation so the remainder becomes diesel fuel)
Suppose we have an example I definitely did not ask ChatGPT to produce for me:
Inputs:
Gasoline is $2.50 / gallon
Diesel fuel: $2.80 / gallon
Crude oil : $70.00 / barrel
There are 42 gallons in a barrel
Calculation:
Sell 1 barrel of gasoline: $2.50 × 42 = $105.00
Sell 1 barrel of gasoline: $2.50 × 42 = $105.00 (again)
Sell 1 barrel of diesel : $2.80 × 42 = $117.60
Total Revenue: $105.00 + $105.00 + $117.60 = $327.60
Crude oil cost: 3 × $70.00 = $210.00
Crack Spread Price: ($327.60 - $210.00) / 3 = $39.20 per barrel
Traders track when to buy or sell each component price to try defending or improving the profit margins per barrel of crude oil processed and thus maximizing gains.
My 8-4-1 Spread Portfolio
I have an 8 year old girl, a 4 year old girl and a 1 year old boy or in other words, a pretty volatile, but flexible 8-4-1 spread to work with and manage everyday.
In this case, it’s not locking in better profit margin per barrel with sophisticated trading strategies; it’s about optimizing a way to wring out an extra 30 minutes of goddamn peace and quiet per day during Summer vacation!
With highly technical tools and strategies, I can adjust my portfolio if volatility and carry costs get out of line -
To the crying 1 year old: “Get the Ball! YAY!”
To the eye-rolling 8 year old: “Clean it up or no trip to TARGET Saturday”
To the cranky 4 year old: “Just go get a snack and I’ll put on Spiderman”
Each move so finely tuned for its product to re-balance the decibel levels to acceptable ranges after garnering knowledge through brute force trial and error experience.
I know when to fade the market —stepping away slowly when they are playing nicely together to let the free time accrue or when to actively hedge by setting up a backyard sprinkler to anticipation of an “I’m bored!” complaint despite having a room full of toys.
At the end of the day, It’s an art, not a science to manage a spread portfolio of this caliber.
What’s your spread? How do you manage it?
Interested in being on the Trader Dads Podcast in 2025? Shoot me an email! I’d love to have subscribers on to sit for a discussion
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Thoughts? Questions? Comments?
Reach out! Maybe I’ll do a full post on the topic or as a Q&A
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