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What is a Crack Spread?

Crude oil as a commodity is a good example of a crack spread.
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  • Written By: Malcolm Tatum
  • Edited By: Bronwyn Harris
  • Last Modified Date: 20 October 2014
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Crack spreads are investing strategies that involve the spread on specific types of commodities. The crack spread is focused on the spread that exists between a core product and the end products that are developed and marketed using the core product. Analyzing the crack spread can assist an investor in purchasing futures that relate to the core product, while at the same time considering the sale of futures options that are related to the derivative products.

One of the best examples of how a crack spread works has to do with the commodity of crude oil. This product serves as the basis for a wide range of desirable goods, such as the sale of gasoline, heating oil, and even some artificial fibers. Because of the range of end products that can be produced with crude oil, securing futures options on the crude oil is often considered a great investment strategy. At the same time, selling futures options on the products created with crude oil at the right time can also help the investor to realize a substantial profit from the venture.

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A key element of determining the degree of crack spread has to do with not only the range of end products that are created with the use of a core product, but also the current market demand for those products. This can sometimes involve considering the current level of demand within a given country or even with a geographical region of the country. Using the example of the crude oil, the investor would choose to acquire crude oil futures at the best possible price. At the same time, the investor would attempt to sell futures options involving gasoline, kerosene or polypropylene when the current market demand is on the upswing, but before the demand begins to level out. By understanding the current difference in value between the core product and the end products, it is possible to determine the crack spread, and engage in buying and selling to best advantage.

Like any investment strategy, the utilization of a crack spread involves carefully researching the commodities involved, assessing current market conditions, and projecting future performance. When utilized properly, a crack spread can provide an investor with important information that can result in a sizable return.

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