ULSD/Crude Spread: The Next Leg Down

About to Tank

On July 29th the December ULSD/crude spread closed below the 100-day Moving Average for the first time since early May.  This triggered and entry signal for the blog, so a hypothetical short position was entered at $13.84 (premium ULSD).  Initially, we are risking to a two-consecutive day close above $15.94.

December ULSD Crude Oil spread daily (200-day MA)Recall that this is happening after the spread briefly pushed above the 200-day Moving Average and rolled over.  When this happened last year, the spread continued to decline for several months and dropped over fifteen dollars per spread.  Just in case this is a replay of2015, we will be watching for setups to pyramid the position.

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ULSD/Crude Spread: Good Place For a Trend Change

A Matter of Semantics

I’ve been trading futures for twenty-five years now.  As on old guy, I still catch myself referring to one of the crude oil derivative contracts as heating oil.  But it’s not.

To comply with EPA rules, the specs for sulfur content on the heating oil contract was changed from 2,000 PPM (sulfur content) to 15 PPM.  Due to this significant modification, the contract was renamed the ultra-low sulfur diesel fuel (ULSD) contract.

Now when you ‘crack’ crude oil at the refinery, the two resulting products are gasoline and ultra-low sulfur diesel fuel (ULSD).  But forgive me if I still occasionally call it the heatin’ oil.  I’m an old trader.

Still Connected

Despite the change in the contract specs, ULSD and crude oil are still highly correlated.  So it’s still a viable candidate for spread trading.

ULSD Crude Oil overlay (nearest-futures 2013-2016) weekly

ULSD Crude Oil overlay (nearest-futures 2013-2016) weekly

As a matter of fact, look at the chart of weekly closing prices of ULSD and crude oil since the contract specs were changed in May of 2013.  Can you tell which market is which?  Didn’t think so.  The ULSD price plot is the red line and the crude oil price plot is the black line.  These two markets appear to stick together like Siamese twins.  As a spread trader, this is exactly what I like to see.

Historic Extremes

Using the heating oil data up until 2013 and the ULSD data since then, we can get over three decades of price history on the charts.  The heat/crude spread used to be expensive when it reached six dollars or higher.  That ceiling was permanently broken in 2005.

In 2004, we learned that crude oil’s previously unsustainable 1990 Gulf War high around $40-per-barrel could not only be surpassed, but in a few years consumers would wish the market could someday come back down to forty dollars!

By 2005, the heat/crude spread had blasted its way to new record highs as well.  The spread never made it back down to the six dollar area until the 2008 financial crisis caused a collapse in energy prices.  Even then, the spread oscillated around six bucks for several months in 2009 and took off on a run for record highs again two years later.

ULSD Crude Oil spread (nearest-futures) weekly

ULSD Crude Oil spread (nearest-futures) weekly

The heat/crude spread reached a crescendo at the October 2012 record high of $43.83.  After converting to the ULSD/crude spread in May of 2013, the spread has made runs to $35.13 in 2014 and $37.89 in 2015.  Despite the recent historic bear market in energies, the ULSD/crude spread has still never touched six dollars yet.

After walking through this history, this spread doesn’t seem very mean-reverting.  So what’s a trader to do?

I think there are two things we can do.  First, we should look at the ratio between ULSD and crude to normalize things.  This will compensate for the spread widening during the period of record high prices and tell us if the relationship between the two markets still shows mean-reverting tendencies.

Second, trade the price action.  Even if the ULSD/crude spread is not as mean-reverting as we might hope, the price action is still what traders should follow.  As long as we are following the trend, the “path or righteousness”, the path of least resistance, etc., we are on the right side of the market.  And if the trend lines up with the direction of historical mean reversion, then that’s just all the better!

Drum Roll…

Good news, folks!  The ratio between ULSD and crude oil does indeed show that the relationship is still very mean-reverting.  As was the case with the heat/crude ratio, the ULSD/crude ratio indicates that things are both expensive and temporary when the ratio exceeds 1.45:1.

ULSD Crude Oil ratio (nearest-futures) weekly

ULSD Crude Oil ratio (nearest-futures) weekly

When the heat/crude ratio reached 1.45:1 or higher in the past, it was only a matter of time until it dropped back down to 1.1:1 or lower.  Now that we’re dealing with the ULSD/crude ratio over the last three years instead, it appears that the upside deviations are followed by declines to either side of 1.2:1 instead of 1.1:1 like the heat/crude did.  This slightly higher downside destination likely just coincides with the change in contact specs.

Daily Pattern

The IMC blog is tracking the December ULSD/crude spread for a trading opportunity.  Now, the ratio is currently around 1.31:1.  Therefore, it is not at an historic extreme of any sort.  The ratio for the December 2016 contracts hasn’t been anywhere close to expensive since it reached 1.43:1 eleven months ago.

However, the spread is worth taking a look at.  First of all, the December ULSD/crude spread rallied as much as $5.90 from the January low.  It just recently closed just above the ever-popular 200-day Moving Average for a few days. Then it lost the upside momentum and started backing off.

This is somewhat similar to what happened last year.  First, the spread rallied as much as $5.81 from the January low.  In May it closed just above the 200-day Moving Average for a few days. Then it lost the upside momentum and started backing off.

Last year, the failure to make it clearly past the 200-day MA was followed by a multi-month decline of over fifteen dollars ($15,000) per spread.  This time, we’re starting from a lower price point.  But you can’t rule out a return to the January low or even another bear market leg down.

December ULSD Crude Oil spread daily (200-day MA)

December ULSD Crude Oil spread daily (200-day MA)

In addition, the multi-month high that the spread reached in early July happens to be just a dime past the Fibonacci .382 retracement of the entire decline from the 2015 high to the current 2016 low.

Over the last couple of months, the December ULSD/crude spread has been supported by the 100-day Moving Average.  The spread first cleared this technical barrier in mid-April.  A sharp pullback in early May caused a closed below the 100-day MA, but it was a one-day event.  The spread snapped right back and made its way to new multi-month highs where it finally reached the 200-day MA.

Daily Pattern

That brings us to what’s going on now.  From the July 11th high -where the spread tangled with the 200-day MA and the Fibonacci .382 resistance line- the spread sold off for five consecutive days and closed at the lowest price in a month.

The rally on Monday and Tuesday then took it back up to just three ticks shy of the Fibonacci .618 retracement of last week’s sell-off.

December ULSD Crude Oil spread daily (100-day MA)

December ULSD Crude Oil spread daily (100-day MA)

The July 18th pullback low at $14.01 and the rising 100-day MA (currently around $13.82) set near-term price support.  A break below this level could indicate that the early July test of resistance was the end of the multi-month run and that the recent bounce to a Fib retracement was a failed recovery.  If so, it would be a good technical reason to short the December ULSD/crude spread.

Trade Strategy:

The blog will work a hypothetical order to sell one 42,000 gallon December ULSD contract and simultaneously buy one 1,000 barrel December crude oil contract on a close below the 100-day MA (currently around $13.82).  If filled, risk a two-consecutive day close 50 cents above the highest close after July 18th (currently at $14.86).

 

Gasoline/Crude Oil Spread: A Stop In the Drop

Out With a Profit

On January 15th, the IMC blog entered a hypothetical short position in the RBOB gasoline/crude oil spread.  After some rollovers, we ended up in the August spread at the equivalent of $21.19 (premium gasoline).

August RBOB Gasoline Crude Oil spread daily

August RBOB Gasoline Crude Oil spread daily

On July 11th the position was liquidated at $13.34.  This was done because the spread had undercut price support between the January 13, 2015 low of $13.24 and the February 9, 2016 low of $13.20 and then reversed higher, triggering a Wash & Rinse buy signal.

The trade resulted in a profit of +$7,850 per spread.  We will now sit on the sidelines and wait until a new setup materializes.

Gasoline/Crude Oil Spread: It’s Now or Never

Batten the Hatches

The IMC blog is holding a hypothetical short position in the August RBOB gasoline/crude oil spread that was entered at the equivalent of $21.19 (premium gasoline) on January 15th.

Price support for this spread was located between the January 13, 2015 low of $13.24 and the February 9, 2016 low of $13.20.  Last week this price level was breached and the spread closed below these lows for three days straight.  This cleared the way for a decline to the current 2016 low of $9.92 on the weekly nearest-futures chart.  If that low is breached, the spread could even drop a few dollars more as it heads for the 2011 and 2013 lows that were established either side of six dollars.

August RBOB Gasoline Crude Oil spread daily

August RBOB Gasoline Crude Oil spread daily

However, a close back above the similar January 2015 and February 2016 lows would trigger a Wash & Rinse buy signal.  This could spark a bear market rally that could potentially run the RBOB gasoline/crude oil spread up a few dollars more.  In light of this potential, we are going to revise our exit criteria to bail out if that scenario materializes.

Trade Strategy:

On the short August RBOB gasoline/crude oil spread entered at the equivalent of $21.19 (premium gasoline), exit on a close above $13.30.

Gasoline/Crude Oil Spread: Roll To August

Extending Our Lease

The IMC blog is holding a hypothetical short position in the July RBOB gasoline/crude oil spread that was entered at the equivalent of $19.61 (premium gasoline) on January 15th.

July RBOB Gasoline Crude Oil spread daily

July RBOB Gasoline Crude Oil spread daily

The big break in the energy markets pushed the July spread down faster than the longer delivery spreads.  Since the July spread has to be rolled or liquidated next week anyhow, we’re going to take advantage of today’s break and roll at the close.

August RBOB Gasoline Crude Oil spread daily

August RBOB Gasoline Crude Oil spread daily

The August spread is currently trading almost $1.50 higher than the July spread.  In addition, the current 2016 high for the August spread is $1.40 lower than the 2016 high for the July spread.  Therefore, rolling to the August spread now and risking to new highs greatly reduces the risk on the trade.  Whenever you can reduce your risk and keep the profit potential the same, you’ve got a no-brainer situation.  Those are usually only obvious in hindsight, so let’s accept this gift that the energy markets have bestowed up on today.

Trade Strategy:

For tracking purposes, the blog will liquidate the short position in the July RBOB gasoline/crude oil spread and simultaneously enter a short position in the August RBOB gasoline/crude oil spread at the market-on-close on Friday, June 24th.  Risk a two-consecutive day close above $21.30.

RBOB/ULSD Spread: Looks Like It Could Tank!

Running Out of Gas?

When you take crude oil to the refinery and ‘crack’ it, you get two products: gasoline and ultra-low sulfur diesel fuel (ULSD).  Therefore, it makes sense that these two energy products would have a strong correlation.

We can talk about the correlation coefficient or discuss fundamental links all day long, but I think there’s a much faster way to determine the correlation between markets.  Simply overlay the price data of a few decades and see if there’s an apparent relationship.  If the two markets typically run together, you’ve got yourself a good market pair for spread trading.

RBOB Gasoline ULSD overlay monthly

RBOB Gasoline ULSD overlay monthly

Now, there will likely be times where one market zigs and the other one zags.  Or there may be times when a market makes a big move and the other makes an anemic move or does nothing at all.  But those are usually where the good spread opportunities materialize.  So it’s not how correlated the markets are all the time, but how correlated they are most of the time.

Having said all of that, take a peek at the last thirty years of monthly closing prices of RBOB and ULSD.  You can see that the two markets are very correlated.

A Note on ULSD

In case you don’t already know, the ultra-low sulfur diesel fuel (ULSD) contract was previously the heating oil contract.  The only difference between them is the amount of the sulfur content.  Three years ago, the distillate fuel contract specs for sulfur content was lowered substantially from 2,000 PPM (sulfur content) to 15 PPM.  The change was made in compliance with EPA rules.

For those of us who rely on price history and statistics to locate trade opportunities, this change has not mattered.  The ULSD contract seems to follow the same seasonal patterns as heating oil and the inter-market relationships continue to function the same way.

Historic Extremes

Given the strong correlation between the gasoline and the ultra-low sulfur diesel fuel, one may wonder if there’s much of an opportunity for a spread trade.  After all, it doesn’t appear that there’s a divergence between the two markets. They seem to be trending closely together.

However, once you plot the difference between the two markets -aka the spread– you will see that there is quite a bit of movement and, therefore, trading opportunities.

Looking at three decades of price history, you can see that the spread has been unsustainable whenever the nearest-futures RBOB has reached a price premium of 20 cents or more over the nearest-futures ULSD.  This year is only the eighth time it has happened in the last thirty years.

RBOB Gasoline ULSD spread (nearest-futures) monthly

RBOB Gasoline ULSD spread (nearest-futures) monthly

The duration of the premium is getting long in the tooth as well.  On a monthly closing basis, the nearest-futures RBOB has closed with a premium of 20 cents or more for three consecutive months.  This matches the record three-month durations of March-May 2004, May-July 2006, and April-June 2007.

If it weren’t for the April 2006 close of 18.46 cents, the spread would have closed above 20 cents for five months in a row.  Nonetheless, the three month duration is still historically stretched.  And in a couple more weeks, the current duration could be stretched to four consecutive months.

The Ratio Confirmation

Coming from a slightly different angle, the ratio between gasoline and ultra-low sulfur diesel fuel also indicates that the RBOB is getting expensive.

RBOB Gasoline ULSD ratio (nearest-futures) monthly

RBOB Gasoline ULSD ratio (nearest-futures) monthly

In March the nearest-futures gasoline/ULSD ratio closed at 1.22:1 on the monthly timeframe.  In the last thirty years, there were thirteen other times when the ratio made it to 1.22:1 or higher (on a monthly closing-basis).  Even then, it proved to be temporary.  The longest duration that the ratio was able to stay at 1.22:1 or higher was four consecutive months.  It eventually turned over and dropped swiftly.

Seasonal Tops

As we just pointed out, right now is only the eighth year in the last thirty that the RBOB gasoline/ULSD spread has reached 20 cents or higher.  Interestingly, The prior seven occurrences all peak around this time of year.

Just one of the tops occurred in June and the other six tops were established in April or May.  This implies that the short sellers should have the wind to their backs now.

Daily Spread Pattern

For trading purposes, we’re going to focus on the August spread.  This gives us two and a half months until we’d have to worry about rollovers.

The August gasoline/ULSD spread may have established a double top-type pattern between the January 20th contract high of 24.52 cents (premium RBOB) and the slightly lower March 29th high of 23.87 cents.  It would take a break below the February 8th low of 6.67 cents to confirm it, but we’d rather be short long before that happens.

August RBOB Gasoline ULSD spread daily

August RBOB Gasoline ULSD spread daily

Furthermore, the spread made a clean break below technical support at the rising 100-day Moving Average this month.  This is a significant event.  Previous drops to either side of the 100-day MA in May 2015, late August/early September, and once again in mid-February were followed by quick recoveries.  This time, it appears to have broken through.  That’s bearish, folks.

Picking My Spot

Now that the 100-day MA has been broken, it goes from being a support line to a resistance line.  So I would normally look to sell the first bounce into the 100-day MA.

However, with US driving season set to kick off during the Memorial Day weekend in just two weeks, there is a chance that the bounce could be significant and initially overshoot the 100-day MA (currently around +17 cents).  So I initially want to lead the target and shoot for a higher resistance level.

A Fibonacci .618 retracement of the current decline off the March high would send the spread up near +20 cents again.  This is coincident with the late April bounce high.  Therefore, a rally into this area could be a nice selling opportunity.

If we get lucky and short the rally, we will certainly look for a setup to add to the position.  A bearish trend reversal could invert the spread and give the ULSD market the price premium.  A break of the February correction low should confirm that this energy spread is going to tank, so we want to take full advantage of that.  So get ready to step on the gas!

Trade Strategy:

The blog will work a hypothetical order to sell one 42,000 gallon August RBOB gasoline contract and simultaneously buy one 42,000 gallon August ULSD (heating oil) contract on a rally to +19.75 cents (premium RBOB).  If filled, risk a two-consecutive day close above +24.75 cents.

Gasoline/Crude Oil Spread: Roll from Spring to Summer

Buying More Time

The IMC blog entered a hypothetical short position in the April RBOB gasoline/crude oil spread at $21.59 (premium gasoline) on January 15th.

Over the last two months, the spread has dropped as low as $17.57 and rebounded as high as $23.47.

The ratio between April RBOB gasoline and April crude oil was at 1.69:1 when we entered the spread. Here we are two months later and the ratio is at 1.63:1. It hasn’t changed much.

Now remember, history shows that gasoline is just too expensive whenever the ratio is at 1.4:1 or higher (basis the nearest-futures ratio). So we still like the short side of this trade.

RBOB Gasoline Crude Oil ratio (nearest-futures) monthly

RBOB Gasoline Crude Oil ratio (nearest-futures) monthly

But with the expiration of the April crude oil contract right around the corner, we’re going to have to roll the position into longer-dated contracts.

Thinking About Summer

Spring starts in just a few days!

So we’re going to roll into a summer spread.

Hey, there’s a reason this is called the futures market…

July 2016 RBOB Gasoline Crude Oil spread daily

July 2016 RBOB Gasoline Crude Oil spread daily

The July RBOB gasoline/crude oil spread is currently trading at a discount of about $1.75 to the April spread. Perhaps this is due to the seasonal tendency for the spread to peak in the spring.

However, the July ratio is still at a historically high level of 1.52:1. On its own merit, that makes the July spread a short sale candidate.

Additionally, the July RBOB gasoline/crude oil ratio has nearly completed a Fibonacci .618 retracement of the decline between the January contract high and the February correction low. This is an ideal technical level to get short.

July 2016 RBOB Gasoline Crude Oil ratio daily

July 2016 RBOB Gasoline Crude Oil ratio daily

We’re gonna roll to the July spread here. Once we get a confirmed downtrend and the right setup, we hope to add to the position. We will keep you posted…

Trade Strategy:

For tracking purposes, the blog will liquidate the short position in the April RBOB gasoline/crude oil spread and simultaneously enter a short position in the July RBOB gasoline/crude oil spread at the market-on-close on Tuesday, March 15th. Risk a two-consecutive day close above $23.00.

Gasoline/Crude Oil Spread: Entry Signal and Bearish Trend Change

In the Tank

Yesterday the April RBOB gasoline/crude oil spread closed below the December 22nd correction low and triggered an entry signal for the blog. A hypothetical short position was initiated by selling one 42,000 gallon April RBOB gasoline contract at $1.2612 (the equivalent of $52.97-per-barrel) and simultaneously buying one 1,000 barrel April crude oil contract at $31.38. This put the entry price on the spread at $21.59.

Initially, we will risk a two-consecutive day close above $25.73. This is 50-cents above the contract high.

Favorable Charts

The chart action preceding the short sale is ideal. Recall that the spread started the year with a breakout to new highs. It then quickly retreated, signaling a failed breakout.

Furthermore, the spread breached the mid-December pullback low on Friday. This is the first time that a prior correction low has been breached. It’s another sign of a bearish trend change.

April RBOB Gasoline Crude Oil spread daily

April RBOB Gasoline Crude Oil spread daily

Hopefully, we’ve nailed the trend reversal on the first attempt. If so, we will be watching for setups to add to a short position. It would make sense to take full advantage of a winning trade and compound it. In the event that we’re wrong, our exit criterion is already in place. Now it’s up to the market to tell us whether we are right or wrong.

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.

Gasoline/Crude Oil Spread: Short a Reversal

Taking Another ‘Crack’ At It

Opportunities abound in the energy crack spreads, which are simply the spreads between crude oil and its derivatives of RBOB gasoline and ultra-low sulfur diesel fuel (formerly known as heating oil). When the products get too expensive or too cheap relative to the crude oil, a bet on the inevitable reversion to the mean can provide a high-probability trade.

Back in the summer, the IMC blog was stalking the RBOB gasoline/crude oil spread for a short sale opportunity. After a record duration of being in overbought territory (six consecutive months of the nearest-futures gasoline/crude ratio above 1.4:1), the spread peaked in August and plunged. Unfortunately, the reversal was so swift and volatile that the reward-to-risk ratio on the trade was no longer attractive. So after all that waiting, we pulled the plug on the trade recommendation. Sometimes, that’s just how it goes.

Driving North For the Winter

After posting a new low for the year in mid-October, the nearest-futures RBOB gasoline/crude oil spread started to recover. So far, it has gained about ten dollars as it rallied from $6.67 to $16.69.

What has our interest is the April RBOB gasoline/crude oil spread. This spread is priced another four and a half dollars higher than the nearest-futures spread. The premium is no surprise. The April delivery contracts are the first of the summer blend contract for the year, which normally trades at a premium to the winter blend contracts.

April RBOB Gasoline Crude Oil spread daily

April RBOB Gasoline Crude Oil spread daily

Technically, the April RBOB gasoline/crude oil spread is at a decision point. Then spread finished last week just above the mid-August high of $21.00, putting it at a fourteen-month high. Coincidentally, this also put it right at the major Fibonacci .618 resistance level. If the rally continues, there is no price resistance until it reaches the March 3, 2014 contract high of $24.90. Conversely, a reversal from here could send the spread several dollars lower.

A Read On the Ratio

As always, we like to take a look at the ratio of any spread that we’re stalking. This can help us clarify what’s going on and determine whether or not the spread is historically over or underpriced.

Last week the April RBOB gasoline/crude oil ratio posted a new contract high of 1.47:1. This slightly clipped the August peak of 1.46:1. Just like in the spread, the ratio may be at a make-or-break level where it needs to accelerate or it will be at risk of a sizable reversal.

April RBOB Gasoline Crude Oil ratio daily

April RBOB Gasoline Crude Oil ratio daily

Recall from previous posts that the nearest-futures gasoline/crude ratio is considered historically expensive anytime it is at 1.4:1 or higher. Then twist here is that the nearest-futures ratio is nowhere near that high. It is the summer blend April contracts that has surged ahead in anticipation.

RBOB Gasoline Crude Oil ratio weekly

RBOB Gasoline Crude Oil ratio weekly

With both the spread and the ratio of the April delivery contracts both just above their August highs, it seems that a sideways market is the lowest-probability outcome. We expect to see either a continuation or a reversal. Seasonal patterns suggest a continuation for the next couple of months. However, we want to have parameters in place to catch a reversal just in case it materializes. Consider us officially back in the hunt for the RBOB gasoline/crude oil spread.

Trade Strategy:

For tracking purposes, the blog will make a hypothetical trade by selling one 42,000 gallon April RBOB gasoline contract and simultaneously buying one 1,000 barrel April crude oil contract if the spread closes below $20.00. If filled, risk a two-consecutive day close of 50-cents above the 2015 high that precedes the entry.