Gasoline/Crude Oil Spread: Raise the Entry Price

Still Rocketing Higher

The IMC blog has been tracking the RBOB gasoline/crude oil spread for a short sale. We switched to stalking the April spread in November to buy more time and to take advantage of the significant price mark-up for the first of the summer blend contract for 2016.

The April spread is priced more than eight dollars over the nearest-futures February spread. This is a big deal as it represents $8,000 more on a single spread.

Since bottoming in mid-October, the April RBOB gasoline/crude oil spread has been on quite a tear. Despite the fact that crude oil tanked to the lowest price in a dozen years, the RBOB gasoline/crude oil spread is actually moving higher. This is because the RBOB is not dropping as fast as the crude. The New Year kicked off with a breakout to a new contract high of $25.22. This marginally surpassed the prior contract high of $24.90, which was set on March 3, 2014.

A twenty-five dollar premium on the gasoline side of the spread is pretty pricey. Over the last three decades, there have been seven occasions where the nearest-futures spread reached $25.00 (premium gasoline) or higher on the monthly timeframe. Each instance preceded a great short sale opportunity. Right now, though, it pays to own a refinery. I hope they are saving up their cash because this fat profit margin won’t last forever.

RBOB Gasoline Crude Oil spread (nearest-futures) monthly

RBOB Gasoline Crude Oil spread (nearest-futures) monthly

Although the April spread hit $25.22 this week, the nearest-futures RBOB gasoline/crude oil spread only made it to $17.45. It’s currently trading under fifteen dollars, so traders who just monitor the front month spreads may not be aware that the summer spreads have reached historically expensive levels. Perhaps this is a hidden opportunity for us?

The Ratio

April RBOB Gasoline Crude Oil ratio daily

April RBOB Gasoline Crude Oil ratio daily

What really has me salivating as a short seller is the fact that the April RBOB gasoline/crude oil ratio also posted a new contract high this week. The ratio actually broke out to new contract highs at the start of December and it has continued to climb since then. This week it closed at a nosebleed level of 1.65:1.

RBOB Gasoline Crude Oil ratio (nearest-futures) monthly

RBOB Gasoline Crude Oil ratio (nearest-futures) monthly

Let’s get a perspective of just how high the April ratio is. History shows that the ratio is expensive anytime it reaches 1.4:1 or higher. On a monthly closing-basis, the RBOB gasoline/crude oil ratio has reached 1.4:1 or higher less than a dozen times in three decades. And there has only been one time ever when the ratio has reached 1.65:1 or higher on a monthly closing-basis (it topped at 1.67:1 last February).

Once again, it is true that the April ratio is trading at a significant premium over the nearest-futures ratio. But this seasonal carry-charge may be a gift for short-sellers. It sure beats looking for a setup to get short at a substantial discount in order to get more time.

Will a Reversal Materialize?

The April RBOB gasoline/crude oil spread cleared the 2014 contract high this week. It then broke lower immediately. This Wash &Rinse sell signal is a failed breakout pattern. The implications are that the top could be in place.

Since bottoming in mid-October, the spread has been in an uptrend with higher highs and pullbacks into higher lows. It pulled back $2.11 from the November 9th high, $1.84 from the early December 1st high, and $2.76 from the early December 11th high. A pullback that’s noticeably more than three dollars off the high could constitute an overbalancing of price and confirm that the trend has changed.

April RBOB Gasoline Crude Oil spread daily

April RBOB Gasoline Crude Oil ratio daily

After the spread traded a dime away from the contract high in early December, it made a sharp pullback to $22.04 on December 22nd. From there it was able to take another stab at new highs. The December 22nd correction low is now a key price support level to watch. If this level is breached, it will be the first time during this run that a prior correction low was broken after new rally highs were made. This would certainly justify a short sale.

Trade Strategy:

On the hypothetical order to sell one 42,000 gallon April RBOB gasoline contract and simultaneously buying one 1,000 barrel April crude oil contract, raise the entry price two dollars from a close below $20.00 to a close below $22.00. If filled, risk a two-consecutive day close of 50-cents above the contract high that precedes the entry.

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