A trader entering a spread with the long side at a discount would love to see it go to a premium. But first it must go through even money. Will two candidates this week be able to do so?
Consider gasoline and heating oil. Their patterns of consumption vary inversely, of course. That of gasoline peaks in July/August, the height of the summer vacation and driving season, just when temperatures are hottest and consumption of heating oil at its nadir. In contrast, consumption of heating oil peaks in winter, just when driving conditions are worst.
In between those two peak seasons are so-called shoulder months. For example, the driving season traditionally ends Labor Day (first Monday in September). Children return to school, and families drive to soccer practice rather than to national parks. Temperatures cool but are not yet cold. Refiners use these months to make the switchover from maximizing production of gasoline to that of heating oil, temporarily slowing production of each.
One would logically think that gasoline for delivery in October, for example, deserves a lesser price than heating oil for delivery then. After all, gasoline consumption is slowing whereas the industry is accumulating inventory of heating oil for cold weather. And it normally does. But even that spread can vary considerably during driving season when gasoline demand is greatest.
From 1986 through 2004, these spreads fluctuated quietly around even money. But in 2005, the character of the market changed drastically. Volatility rose sharply, and gasoline most typically traded at a discount --- sometimes an exceptionally large discount. The 15-year seasonal pattern for the October relationship, for instance, suggests gasoline starts trading at well under value to heating oil as the prior heating season begins but then outperforms heating oil throughout winter.
With the arrival of spring, it actually stalls for a while, but then it has usually made a final runup throughout the first month of summer. For example, the Long October Gasoline/Short October Heating Oil spread has closed more favorably toward gasoline on about July 21 than on about June 20 in 13 of the last 15 years --- suffering a daily closing drawdown greater than 1.60 cents/gallon in only 4 of those years. (Each 1.00 cent/gallon is worth $420.)
This year the spread began trading last October with gasoline at a discount to heating oil of about -23.00 cents/gallon --- near the middle of the range for the last decade or so. That discount then narrowed sharply, trading through even money and actually to a modest premium of 2.79 in January --- traditionally the coldest month of the year! It then retraced 60% of its rise as it pulled back into February to trade at a discount of -12.30. But then it made yet another run into April, reaching another albeit even more modest premium.
The spread has now returned to a discount and is actually testing the February extreme. In fact, it traded as wide as -10.70, narrowed to -8.62, and ended to week retesting -10.00. Will this area hold? If so, can it generate another run toward even money as the Fourth of July holidayopens up summer to cross country driving and weekend cruising?
Please remember: These are NOT trading recommendations. They are intended only as potential ideas based on the market's own performance in the past, but past performance is not necessarily indicative of future results. Futures trading involves substantial risk of loss.
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