In Spring, Oil Traders’ Thoughts Turn To Spreads

March 11, 2010


Gasoline (RB) - Heating Oil (HO) Spread

Gasoline (RB) - Heating Oil (HO) Spread


Ordinarily, there's a strong seasonality to the spread. Gasoline prices, relative to heating oil, are typically weakest in the late fall and winter, and gain strength to peak by late spring or summer.

Although fairly reliable, the trend isn't a guarantee of profit. Look what happened in 2008. Uncertainty over the country's economic prospects sent petroleum prices tumbling over the Independence Day holiday, hitting gasoline hardest as seasonal and discretionary demand weakened precipitously.  

We're now returning to a more normal pattern and seeing gasoline prices spiking above heating oil. Spot RBOB recently broke definitively above the $2.00 level, retracing half of its 2008 swoon and now seems ready to challenge resistance at $2.50. Gasoline's breakout pushed its premium over heating oil to 16 cents per gallon, aiming for a test of the 26-cent level reached last May.

Gasoline traders might be tempted to buy futures here, but doing so means coughing up at least $5,400 as a margin deposit. If there's a quick leg up to the $2.50 level, the potential return on margin would be about $3,800. That comes, however, with the risk that a 4-cent-per-gallon decline from their entry price would put them on call for additional margin.

Given the 42 percent annualized volatility in gasoline prices, a spread trade seems a better approach. Buying gasoline futures against the sale of a heating oil contract entitles a trader to a 65 percent margin credit on each leg, making the performance bond only $3,780.

The wager made by the spread trader is less directional and more relational. As long as gasoline's premium widens from its present 16-cent level, by any combination of gasoline advances and/or heating oil declines, the spreader makes money. A 10-cent swelling of the premium translates to a $4,200 gain. The spread has to lose 4 cents, or narrow below 12 cents per gallon, to trigger a margin call. Presently, however, the breakout has developed support at the 10-cent level, providing a comfortable cushion of a couple of pennies.

In the spread game, every penny counts.


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