Hedging 401: Spreads
Over the last two years the Westlark Team has created three blog series about “hedging” (Hedging 101, 201, 301). The goal of these series is to help everyone gain a better understanding of what financial hedging is and how its tools can be used to benefit your business.
This year, we want to continue this educational trend with a new series: Hedging 401. In this series, we will explore the concept of spreads – what they are, what they mean, and how they are used in the marketplace.
Spreads Defined
With any new topic, it is vital to look at definitions. Defining important terms sets the foundation for our study. For example, take the word – spread. Many things could come to mind when you hear the word spread. You could be thinking of butter being smoothed onto a piece of bread. You could also picture a table or counter loaded with a wide variety of snacks and drinks. Football fans might visualize their favorite team using a “shotgun spread” offense. All of these thoughts are accurate uses of the word spread. However, when used in a financial hedging context, the word spread has a different definition.
A spread represents the difference between either two pricing points or two different locations.
If we are looking at a forward price curve for natural gas that has prices from June 2026 all the way to the end of December 2035, we could define a spread as the price difference between those two time periods. If we are looking at the same grade of oil that is sitting in a storage facility in Cushing, Oklahoma, and then oil stored in Louisiana, we could define a spread as the difference between those two locations.
How to Talk About Spreads
One of the key factors when discussing a spread is that the spread is always defined as the difference between point 1 and point 2 or location 1 and location 2. While that might seem obvious, it’s vital when you look at understanding communication on spreads.
Here’s an example to demonstrate this point:
- Propane price for June 2026 = $.90/gallon USD
- Propane price for January 2027 = $1.00/gallon USD
- The Spread between these dates = negative 10 cpg (cents per gallon) OR ($.10/gallon USD)
Describing the spread as 10 cpg without any context leaves the listener unsure about the price relationship. A simple statement of a 10 cpg spread in the trading community will imply that June’s propane prices are 10 cpg HIGHER than January. However, that is not the case in our example. January is actually 10 cpg HIGHER than June’s value.
This is why it is vital to always know that spreads refer to the difference between price 1 and price 2 AND that we communicate that spread with a positive or negative value to emphasize the relationship between those two points.
Conclusion
As a starting point, this post may seem a bit simplistic, but it is necessary. We will build on these concepts of what spreads are and the information they communicate to us about markets in later posts. Stay tuned for more Hedging 401 posts as we move through this summer!
Hedging 401: Part One – Spreads
By JD Buss
