Crack spread
Also written Crack spreads
An inter-commodity spread strategy in the energy complex — trading crude oil futures against futures on the petroleum products refined from it — used to lock in a refiner's margin.
In plain language
A refiner buys crude oil and sells finished products like petrol and diesel. Its profit is the gap between what it pays for crude and what it earns from the products it "cracks" the crude into.
That gap can be traded directly in the futures market, without ever running a physical refinery. That trade is the crack spread — crude oil futures against petroleum product futures, in the energy complex.
How it works
The crack spread is an inter-commodity spread, made up of a position in one commodity against a position in a different but economically related commodity. Specifically, it refers to the energy complex, where trading happens between crude oil and the petroleum products extracted from it — and it helps lock in refining margins.
Structurally it works exactly like the workbook's other named inter-commodity spread, the crush spread: a trader takes offsetting positions in the raw input and its refined outputs, so that a change in the overall spread between them — rather than the outright direction of energy prices — drives the trade's profit or loss.
A worked example
A refiner processing crude oil into petrol and diesel is exposed to the spread between crude oil cost and product revenue, not simply to the crude oil price itself. To lock this margin in advance, it buys 100 barrels of crude oil futures at Rs 6,800 per barrel (Rs 6,80,000) and sells matching petrol and diesel futures worth a combined Rs 7,50,000 (all figures illustrative) — a crack spread that locks in today's implied refining margin of Rs 70,000.
If crude oil futures later rise to Rs 7,100 per barrel (Rs 7,10,000) while the product futures rise by less, to a combined Rs 7,64,000, the position still nets Rs 54,000 — smaller than before, but protected from the outright direction of energy prices. A speculator with no refinery at all can take the same two-legged position, profiting or losing purely on how the crude-to-product margin moves, without ever taking delivery of either the crude or the refined fuel.
Why NISM asks about it
Chapter 5, in the section on inter-commodity spreads, names crack spread and crush spread as the paper's two worked examples — crack for energy, crush for the soyabean complex. Expect a question that asks which spread belongs to which commodity family: crack spreads to energy (crude and its refined products), crush spreads to oilseeds (soyabean, soyabean meal and soyabean oil).
Common exam traps
- Crack spread is energy; crush spread is oilseeds. The two names are frequently swapped in multiple-choice options.
- It is an inter-commodity spread, not an intra-commodity (calendar) spread. The two legs are on economically related but different commodities, not on different expiry months of the same commodity.
- The purpose is to lock a refining margin, not to make a directional bet on crude oil prices alone — a pure long or short crude position is a different trade with different risk.
Check yourself
1.What are "crush spreads" and "crack spreads"?
- a)Crush spreads relate to the soyabean complex (buy soyabean, sell soyabean meal and soyabean oil in a specific proportion) to lock processing margins; crack spreads relate to the energy complex (crude oil versus products extracted from it) to lock refining margins
- b)Crush spreads relate to crude oil refining; crack spreads relate to oilseed processing
- c)Both are intra-commodity calendar spreads in the same underlying
- d)Both are option strategies combining calls and puts on the same commodity
Show the answer
Answer: (a) Crush spreads relate to the soyabean complex (buy soyabean, sell soyabean meal and soyabean oil in a specific proportion) to lock processing margins; crack spreads relate to the energy complex (crude oil versus products extracted from it) to lock refining margins
"CRUSH SPREADS: It specifically refers to SOYABEAN COMPLEX whereas the spread trader BUYS SOYABEAN AND SELL SOYABEAN MEAL AND SOYABEAN OIL IN A SPECIFIC PROPORTION TO LOCKING PROCESSING MARGINS."
"CRACK SPREADS: This strategy specifically refers to the ENERGY COMPLEX, where trading happens BETWEEN CRUDE OIL AND PETROLEUM PRODUCTS extracted from it. It helps LOCK REFINING MARGINS."
Both are types of inter-commodity spread: "a long position in one commodity and a short position in a different but economically related commodity."
Why the other options are wrong:
- (b) swaps the two.
- (c) They are inter-commodity (different but related commodities), not intra-commodity calendar spreads.
- (d) They are futures spreads, not option combinations.
Memory hook: you crush beans and crack crude.
Where this is taught
Free preparation for NISM Series XVIRelated terms
- Buying a spreadAn intra-commodity spread trade — buying the near-month futures contract and simultaneously selling the far-month contract — taken when the near month looks underpriced or the far month overpriced relative to fair value.
- Crush spreadAn inter-commodity spread specific to the soyabean complex — buying soyabean futures and selling soyabean meal and soyabean oil futures in a set proportion — used to lock in a processor's crushing margin.
- Inter-commodity spreadA long futures position in one commodity and a short position in a different but economically related commodity for the same month — such as guar seed against guar gum — to trade the gap between them.
- Intra-commodity spreadA long futures position in one contract month and a short position in another month (or a different lot size) of the same commodity, taken to profit from a change in the gap between them.
- Naturally longThe position every business holds in its finished goods — it gains when their prices rise and loses when they fall, which is why finished goods are hedged by selling futures.