Inter-Commodity Spread Trading

A calendar spread trades the same commodity against itself across time. An inter-commodity spread trades two different commodities against each other, when there is an economic reason their prices should stay linked — a refiner turns crude oil into gasoline, so crude and gasoline prices move together; a soybean processor turns beans into meal and oil, so those three prices move together; gold and silver are both monetary metals mined by overlapping producers, so their ratio tends to stay within a range. The spread trader isn't betting on either commodity's direction — only on whether the linkage between them is about to widen or narrow.

The classic example: the crack spread

Refiners buy crude oil and sell refined products like gasoline and heating oil; their margin is the difference, called the crack spread. A common approximation, the "3-2-1 crack," models three barrels of crude turning into two barrels of gasoline and one of heating oil:

$$\text{Crack} = 2 \times P_{gas} + 1 \times P_{heat} - 3 \times P_{crude}$$

In words: take the revenue from selling two units of gasoline and one of heating oil, subtract the cost of the three units of crude that produced them, and the remainder is the refiner's implied margin per barrel processed. A trader who thinks refining margins are about to widen — say, ahead of a seasonal jump in gasoline demand — buys gasoline and heating oil futures and sells crude futures in that 2:1:3 ratio, profiting if the spread widens regardless of whether oil prices as a whole go up or down.

Worked example

Crude is $78/barrel, gasoline is $2.35/gallon ($98.70/barrel-equivalent at 42 gallons/barrel), and heating oil is $2.55/gallon ($107.10/barrel-equivalent). The 3-2-1 crack: $2(98.70) + 1(107.10) - 3(78) = 197.40 + 107.10 - 234 = 70.50$, or about $23.50 per barrel processed. If a trader believes seasonal driving demand will push gasoline up faster than crude, and a month later gasoline rises to $2.55/gallon ($107.10/barrel) while crude and heating oil are unchanged, the crack rises to $2(107.10) + 107.10 - 234 = 88.50$, up $18 per barrel — a gain on the spread even if a pure long-crude position was flat.

What this means in practice

Inter-commodity spreads let a trader isolate a specific economic view — refining margins, crush margins in soybeans, the gold-silver ratio's mean-reverting tendency — while netting out the broad commodity-market direction that dominates outright positions.