Crush Spread & How to Trade It

Written By

Dan Buckley

Updated

Jun 4, 2024

The crush spread is a trading strategy used in the commodities market – specifically within the agricultural sector.

It involves the simultaneous purchase and sale of soybean futures and its derivative products, soybean meal and soybean oil, to exploit pricing inefficiencies and manage risk.

This spread provides insights into the profitability of processing soybeans into its two main products.

Key Takeaways – Crush Spread

A crush spread is an options/futures trading strategy that combines long and short positions in commodity futures and options contracts.

It’s designed to profit from a change in the crush spread – i.e., the difference between the cost of the inputs (e.g., soybeans) and the value of the outputs (e.g., soybean oil and meal).

Traders execute a crush spread by simultaneously buying (or going long) the commodity futures and selling (or going short) the options on the processed products, or vice versa, depending on their view of the crush spread’s direction.

Changes in the crush spread, volatility, and time decay can majorly impact the position’s profitability.

Components of Crush Spread

Soybeans

Soybeans are the raw agricultural commodity that is processed into two main products:

soybean meal
soybean oil

Traders buy soybean futures to establish a long position in the raw product.

Soybean Meal

Soybean meal is a byproduct of soybean processing and is primarily used as animal feed.

Traders sell soybean meal futures to establish a short position in one of the processed products.

Soybean Oil

Soybean oil is another byproduct of soybean processing and is used for cooking, as an ingredient in food products, and in the production of biodiesel.

Traders sell soybean oil futures to establish a short position in the second processed product.

Calculating Crush Spread

Futures Prices

The crush spread is calculated using the futures prices of soybeans, soybean meal, and soybean oil.

The prices of these futures contracts are typically quoted on commodity exchanges such as the Chicago Board of Trade (CBOT).

Formula

The basic formula for the crush spread is:

Crush Spread = (Price of Soybean Meal x 0.022) + (Price of Soybean Oil x 0.11) – Price of Soybeans

This formula accounts for the conversion ratios:

1 bushel of soybeans typically produces approximately…
44 pounds of soybean meal (0.022 short tons) and
11 pounds of soybean oil

Uses and Significance

Profitability Analysis

The crush spread provides insight into the profitability of processing soybeans.

A positive spread indicates that the combined value of soybean meal and soybean oil exceeds the cost of soybeans, suggesting profitable processing margins.

Conversely, a negative spread indicates potential losses.

Risk Management

Processors and traders use the crush spread to hedge against price volatility in the soybean complex.

By locking in a favorable spread, they can reduce the risk of adverse price movements in the underlying commodities.

Market Signals

The crush spread can also serve as an indicator of supply and demand dynamics in the soybean market.

Changes in the spread can reflect shifts in the relative values of soybeans, soybean meal, and soybean oil, providing traders with valuable market signals.

Trading Strategies

Long Crush Spread

A long crush spread strategy involves buying soybean futures and selling soybean meal and soybean oil futures.

This strategy profits from an increase in the value of processed products relative to the cost of soybeans.

Short Crush Spread

Here, a short crush spread strategy will involvesselling soybean futures and buying soybean meal and soybean oil futures.

And this strategy profits from a decrease in the value of processed products relative to the cost of soybeans.

To illustrate a specific trade involving the crush spread, we’ll walk through an example of both a long crush spread and a short crush spread.

Long Crush Spread

Objective

The objective of a long crush spread is to profit from an increase in the value of soybean meal and soybean oil relative to the cost of soybeans.

Trade

Identify the Futures Contracts:

Soybean Futures (e.g., ZS)
Soybean Meal Futures (e.g., ZM)
Soybean Oil Futures (e.g., ZL)

Determine the Contract Quantities:

Soybeans: 1 contract (5,000 bushels)
Soybean Meal: 11 contracts (100 short tons per contract)
Soybean Oil: 11 contracts (60,000 pounds per contract)

Example Prices:

Soybeans: $14.00 per bushel
Soybean Meal: $400 per short ton
Soybean Oil: $0.50 per pound

Calculate Initial Position:

Buy 1 Soybean Futures Contract: 5,000 * 14.00 = $70,000
Sell 11 Soybean Meal Futures Contracts: 11 * 100 * 400 = $440,000
Sell 11 Soybean Oil Futures Contracts: 11 * 60,000 * 0.50 = $330,000

Execute the Trades:

Buy 1 contract of Soybean Futures (ZS)
Sell 11 contracts of Soybean Meal Futures (ZM)
Sell 11 contracts of Soybean Oil Futures (ZL)

Monitor the Spread:

Keep track of the prices of soybeans, soybean meal, and soybean oil.
The position profits if the combined value of soybean meal and soybean oil increases relative to the cost of soybeans.

Short Crush Spread

Objective

The idea of a short crush spread is to profit from a decrease in the value of soybean meal and soybean oil relative to the cost of soybeans.

Trade

Identify the Futures Contracts:

Soybean Futures (e.g., ZS)
Soybean Meal Futures (e.g., ZM)
Soybean Oil Futures (e.g., ZL)

Determine the Contract Quantities:

Soybeans: 1 contract (5,000 bushels)
Soybean Meal: 11 contracts (100 short tons per contract)
Soybean Oil: 11 contracts (60,000 pounds per contract)

Example Prices:

Soybeans: $14.00 per bushel
Soybean Meal: $400 per short ton
Soybean Oil: $0.50 per pound

Calculate Initial Position:

Sell 1 Soybean Futures Contract: 5,000 * 14.00 = $70,000
Buy 11 Soybean Meal Futures Contracts: 11 * 100 * 400 = $440,000
Buy 11 Soybean Oil Futures Contracts: 11 * 60,000 * 0.50 = $330,000

Execute the Trades:

Sell 1 contract of Soybean Futures (ZS)
Buy 11 contracts of Soybean Meal Futures (ZM)
Buy 11 contracts of Soybean Oil Futures (ZL)

Monitor the Spread:

Monitor the prices of soybeans, soybean meal, and soybean oil.
It profits if the combined value of soybean meal and soybean oil decreases relative to the cost of soybeans.

Example Calculation

Long Crush Spread Example

Initial Spread Calculation:

Initial cost of Soybeans: 5,000 * 14.00 = $70,000
Initial value of Soybean Meal: 11 * 100 * 400 = $440,000
Initial value of Soybean Oil: 11 * 60,000 * 0.50 = $330,000
Initial Crush Spread: ($440,000 + $330,000) – $70,000 = $700,000

Closing Spread Calculation (assuming prices change):

Soybeans increase to $15.00 per bushel
Soybean Meal increases to $420 per short ton
Soybean Oil increases to $0.55 per pound
Final cost of Soybeans: 5,000 * 15.00 = $75,000
Final value of Soybean Meal: 11 * 100 * 420 = $462,000
Final value of Soybean Oil: 11 * 60,000 * 0.55 = $363,000
Final Crush Spread: ($462,000 + $363,000) – $75,000 = $750,000
Profit: $750,000 – $700,000 = $50,000

Short Crush Spread Example

Initial Spread Calculation:

Initial cost of Soybeans: 5,000 * 14.00 = $70,000
Initial value of Soybean Meal: 11 * 100 * 400 = $440,000
Initial value of Soybean Oil: 11 * 60,000 * 0.50 = $330,000
Initial Crush Spread: ($440,000 + $330,000) – $70,000 = $700,000

Closing Spread Calculation (assuming prices change):

Soybeans decrease to $13.00 per bushel
Soybean Meal decreases to $380 per short ton
Soybean Oil decreases to $0.45 per pound
Final cost of Soybeans: 5,000 * 13.00 = $65,000
Final value of Soybean Meal: 11 * 100 * 380 = $418,000
Final value of Soybean Oil: 11 * 60,000 * 0.45 = $297,000
Final Crush Spread: ($418,000 + $297,000) – $65,000 = $650,000
Profit: $700,000 – $650,000 = $50,000

In both examples, the profitability of the trades depends on the changes in the prices of soybeans, soybean meal, and soybean oil.

Traders need to carefully monitor these prices to manage their positions effectively.