FIN 376: Trading the Crush Spread

Before Thanksgiving break we took a short position in the 3:2:1 crack spread (bought 3 CL, and sold 2 RB and 1 HO of the next month). We'll make money on this position if the refining margin on crude oil declines - that is, we use this spread to hedge our refining margin if we are a oil refiner like VLO or TSO.

 Today, we'll hedge another refining margin known as the crush spread. This is the margin when processing soybeans into soy meal and soy oil. A good introduction into the crush spread is `The Soybean Complex Spread: An examination of market efficiency from the viewpoint of a production process' by Johnson et al. (Journal of Futures markets, 1991).

 In the paper the authors use a mean reverting trading strategy to trade the crush spread. When the spread gets wider than the long-term processing costs they short the spread (buy soybeans, sell meal and oil). This means they expect more processors to come online and the processing spread to decline (revert to the long-term mean). Conversely, when the spread gets narrower than the long-term processing costs they buy the spread (sell soybeans, buy meal and oil). This means they expect more processors to go offline and the processing spread to increase.

** Note in the paper they are testing market efficiency with this trading strategy, but this strategy is often used to hedge and not speculate - though speculation is fine.

The long-term average is that one bushel of soybeans (60 lbs) crushes into 48 lbs of meal and 11 lbs of oil. Given CBOT contract sized this means we will use a 1:1:1 trade (one contract of each soybeans, meal, and oil) even though the exact relationship would be 1 soybeans to 1.2 meal and 0.915 oil.

To calculate the Gross Crushing Margin we'll use Eq 1 of the paper:

GCM = (FM*48)/2000 + (FO*11)/100 - FS

where
FM is the futures price of meal in $ per ton
FO is the futures price of oil in in $ per 100 pounds
FS is the futures price of soybeans in $ per bushel
 all futures are at tome t for delivery at time t+n.  

Note on the ECBOT symbols for soybeans is ZS, meal is ZM, and oil is ZL.

EDIT: Using the following prices, ZS = (434.1*48)/2000+(50.42*11)/100-$14.505  = $1.4596

which is a margin as a percent of the cost of soybeans of $1.4596/$14.505 = 10.06%

Email this to someoneShare on RedditTweet about this on Twitter

Leave a Reply

Your email address will not be published. Required fields are marked *