Page 167 - DCOM510_FINANCIAL_DERIVATIVES

Financial Derivatives

Notes
Figure 10.9: Portfolio Office Order Entry for Basket Trades

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Case Study A Refiner Fixing his Margins through a Simple 1:1
Crack Spread

n January, a refiner reviews his crude oil acquisition strategy and his potential distillate
margins for the spring. He finds that as per his research, the distillate prices are
Iexpected to be strong. He plans a two-month crude to distillate spread strategy. This
will allow him to lock in his margins.
In May, the spread between August crude ($134 per barrel) and September heating oil
($3.8786 per gallon or $162.9012 per barrel) presents what he believes to be a favourable
$28.9012 per barrel.
The refiner sells the Aug/Sept crude-to-heating oil spread, thereby locking in the $28.9012/
bbl. margin. He does this by buying August crude oil futures at $134/bbl. and selling
September heating oil futures at $3.8786/gal.
In July, he purchases the crude oil at $137/bbl in the cash market for refining into products.
He also sells heating oil from his existing stock in the cash market for $3.8985/gal. or
163.7370/bbl. His net gain in the cash market is therefore $26.7370/bbl. (163.7370/bbl.-
137/bbl)
Contd....

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