Inter-commodity spread
A 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.
In plain language
Some commodities are joined by an economic relationship: one is the raw material and the other the product, or they compete for the same demand. Their prices drift apart and come back together.
An inter-commodity spread trades that relationship. The trader is long one commodity and short the related one, usually for the same calendar month, and profits if the gap between them moves the way he expects.
The workbook's examples are guar seed and guar gum, and soyabean and soya oil.
How it works
Structure. Long one commodity, short a different but economically related commodity, same calendar month (Chapter 5, section 5.5).
Named types:
| Spread | Complex | What it locks |
|---|---|---|
| Crush spread | Soyabean: buy soyabean, sell soyabean meal and soyabean oil in a specific proportion | Processing margins |
| Crack spread | Energy: crude oil against petroleum products extracted from it | Refining margins |
Going long or short the spread. If the spread is defined as the higher-priced product minus the raw material, then buying the raw material and selling the product is a short position in the spread: it gains when the spread falls.
Margin benefit. Under SEBI's March 2023 circular, a spread between two different commodities such as a commodity complex can get a benefit of up to 50 per cent of total initial margin — but only if the two have a correlation of 0.90. ELM applies to each leg separately, and each contract must be among the first six expiring.
Related cross-margin. For index futures, SEBI's 29 June 2021 circular allows a cross-margin benefit of up to 75 per cent on opposite positions in index futures and futures of its constituents, which the workbook compares to the crush margin benefit between oilseeds and their vegetable oils.
A worked example
The workbook's guar trade. On 1 June a trader expects the gap between guar gum and guar seed to narrow — guar seed supplies are dwindling while guar gum is expected to be in surplus. He buys guar seed and sells guar gum, which is a short position in the spread.
| June guar seed | June guar gum | Spread (gum - seed) | |
|---|---|---|---|
| 1 June | Buy at 6,010 | Sell at 11,120 | 5,110 |
| 16 June | Sell at 6,075 | Buy at 11,050 | 4,975 |
| Result | +65 | +70 | -135 |
Net profit = 65 + 70 = 135
Spread change = 4,975 - 5,110 = -135
He made exactly what the spread fell by. Here both legs happened to gain, but the trade did not depend on that: had both prices risen by 300, the spread and his profit would be unchanged.
In rupees. If both legs covered 100 quintals (illustrative — actual lot sizes differ by contract):
135 x 100 = Rs 13,500
The margin. Guar seed and guar gum form a commodity complex. If their correlation meets 0.90, the pair could qualify for up to a 50 per cent spread margin benefit; ELM would still be charged on each leg.
Why NISM asks about it
Chapter 5, section 5.5 (Spread Trading), defines inter-commodity spreads, gives the guar seed / guar gum table, and names crush and crack spreads; the same section states the 50 per cent benefit and 0.90 correlation test. Chapter 7, section 7.12.1, refers to the crush margin benefit when explaining cross-margin on index futures. Expect "crush spread relates to which complex?", "crack spread locks which margin?", and the guar calculation.
Common exam traps
- Inter = two different, related commodities; intra = the same commodity in different months.
- Crush is soyabean; crack is crude oil. Crush locks processing margins, crack locks refining margins.
- Buying guar seed and selling guar gum is a short position in the spread as the workbook defines it — it gains when the spread falls.
- Same calendar month for both legs in the workbook's definition.
- Up to 50 per cent margin benefit, only with correlation of 0.90 — not the 75 per cent available for same-commodity spreads.
- The profit equals the change in the spread, not the change in either price.
- The 75 per cent cross-margin on index futures is a separate SEBI benefit (June 2021) for index-versus-constituent positions, not an inter-commodity spread benefit.
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
- Extreme Loss MarginA flat 3.5 per cent margin collected on cash-market positions to cover losses falling outside what the VaR margin is designed to capture.
- Initial marginThe deposit both the buyer and the seller of a futures contract must place before the position is accepted, sized to cover a 99% worst-case one-day loss on that position.
- Crack spreadAn 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.
- 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.
- 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.
- 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.
- Spread margin benefitThe lower overall margin SEBI permits on a spread position versus margining each leg on its own — up to 75% for the same commodity, up to 50% across two related commodities.