4 Factors You Didn't Know About RBOB

The dropping price of crude oil has gotten a great deal of attention from the financial media in 2015 and early 2016. Prices went from over $100 a barrel in June 2014 to around $30 a barrel by January 2016. This price drop has led to volatility in other markets including the stock market.

Fluctuations in the price of gasoline have received less coverage. Consumers have definitely appreciated lower gasoline prices at the pump. Although a futures contract for gasoline does not have as much volume as that for crude oil, it is still an important hedging tool for market participants. It can also be used for purposes of speculation.

Gasoline is a byproduct of the refining of crude oil. Crude oil is composed of a number of different hydrocarbons. The hydrocarbons have chains of molecules of different lengths. The longer the chains, the heavier the hydrocarbon. The different chain lengths have higher boiling points as they get longer.

Oil refineries separate out the different chains by heating the crude oil to certain vaporization points. Gasoline is created by the vaporization of chains with boiling points below that of water. These different chains are blended together in various amounts to provide a consistent product for gasoline.

The most common way to trade gasoline is through a futures contract. Although there are a couple of different contracts for gasoline, the most common is the RBOB contract. RBOB stands for reformulated blendstock for oxygenate blending. The contract is traded on the Chicago Mercantile Exchange (CME) under the symbol RB. The price for the contract is quoted in U.S. dollars and cents. The minimum price tick for RBOB is 0.0001 which works out to a price move of $4.20 for one contract.

The contract unit is for 42,000 gallons or 1,000 barrels. The initial margin to hold one futures contract is $4,460, with a maintenance margin of $4,060, as of February 2016. These margin amounts are subject to modification by the CME based on the volatility of the contract. There are monthly contracts for the current calendar, as well as the next three calendar years plus one additional month.

The contract is settled by physical delivery. This means most investors need to liquidate their positions prior to the expiration of the contracts. If a position is not liquidated, the holder of a long contract is responsible for taking delivery of 42,000 gallons of gasoline. It is safe to say most investors do not want to take physical delivery of that much gas. Thus, investors must be aware of the different deadlines for futures contracts.

In addition, investors should understand how the use of leverage in futures trading can magnify both profits and losses. One option for investors may be to use calendar spreads for trading purposes. A calendar spread involves the simultaneous trading of a long futures position in one month and a short futures position in another month. For example, the margin on a calendar spread buying the April 2016 futures contract and selling the May 2016 futures contract is $910, which is much lower than the margin for just a long or short futures position.

This margin amount is lower because the two contracts have a high degree of correlation and generally move in the same direction together. There are still significant risks even when trading calendar spreads. Another possibility for investors may be option spreads that often have defined profits and losses when structured in a certain manner.

Prices for RBOB logically have a high degree of correlation with crude oil since gasoline is distilled from crude. Thus, the global supply and demand factors for crude oil also apply to RBOB. Still, the RBOB market has its own supply and demand factors. Many of the refineries for gasoline are located in the U.S. Gulf Coast region. Weather issues in that area can drive up the price for RBOB. Another important factor to consider is that gasoline is heavily taxed in many jurisdictions. This can also impact supply and demand for RBOB.