No, we're talking proper arbitrage opportunities. Not the sort of casual correlations that have brought many a trader down. Like the idea that investors must choose between holding bonds or equities, and therefore if one goes up in price the other must go down. This sloppy thinking is exactly what bankrupted the once venerable Barings Bank whose management had too much faith in Nick Leeson's wizardry with Nikkei versus JGB futures.
Proper arbitrage consists of buying one instrument against another, a derivative or otherwise, where there is a precise mathematical formula that stipulates where each one will settle relative to the other at the end of a specified time period. This is how I started my trading career (a very long time ago) with a Hewlett-Packard scientific calculator, money market interest rates and futures contracts on these.
The oil industry has done the same for decades, splitting out the different components of a barrel of oil - which in itself comes in various grades, the lightest needing the least refining. Delivery locations too have associated costs - Brent in Rotterdam versus West Texas Intermediate at the pipeline in Cushing, Oklahoma. So, too, agricultural traders with the soy bean crush - oil plus mash equals beans.
M&G Investments estimates that the bulk of every barrel of crude oil still goes into making gasoline (42.7 per cent), diesel and heating oils (30.4 per cent); jet fuel 9.2 per cent, petrochemical feedstock a paltry 1.7 per cent and the last 16 per cent into other bits and bobs including lubricants. Futures and options exist on all these except, funnily enough, feedstock. Sort out the proportions, do the maths, and Bob's your uncle.
If only. This is obviously no trade secret, it just requires time and money. To gain an added edge traders will also try to include potential directional price moves as variation margin received can be reinvested - a worthwhile bonus when interest rates were higher.
With this in mind look at the charts. WTI futures appear to have based against the $25 level retracing half of last year's decline. Chances are they'll hold above January's low so buying dips might give you a small edge. The picture for Brent is similar, but seeing as it's so close to the psychological $50 level, gains might be slightly more difficult to maintain (not forgetting the fairly grim outlook for Europe's economies).
Heating oil too has rallied for three consecutive months, but gains are smaller, retracing just one-third of the losses since 2015's interim high. Blame it on the weather, technological improvements, fuel poverty, or whatever. Chances are that shorting this one over the others, in the correct proportion, of course, might make a tiny bit more money.
Finally unleaded gasoline, not forgetting the more recent impact of biofuels; the hit to the consumer wallet makes it a far more emotive barometer. Rallying strongly from the same low as registered at the end of 2008, back within 1.5 standard deviations of the long-term mean regression, this one has more of a bounce in its step, something that might well continue through the Northern hemisphere's summer.
