Basis (Futures)

The basis is the difference between the futures contract price and the spot price of the underlying asset. Basis = Futures Price − Spot Price. When a futures contract is more expensive than spot (positive basis), the market is in contango. When a futures contract is cheaper (negative basis), the market is in backwardation. The basis reflects the cost-of-carry (storage, financing, insurance) and converges to zero at expiration date, creating opportunities and risks for hedgers.

Basis and cost-of-carry

The basis is fundamentally linked to cost-of-carry. When you buy oil today and store it for 6 months, the futures price should equal spot plus storage + financing. The difference is the basis.

Basis = Cost-of-carry

For example:

• Spot oil: $70/barrel
• 6-month storage: $2/barrel
• 6-month financing (interest): $1.50/barrel
• Expected 6-month futures: $73.50
• Basis: $73.50 − $70 = +$3.50 (positive, signaling contango)

Basis convergence

As a futures contract nears expiration date, the basis shrinks. At expiration, the futures price must equal the spot price; there is no difference. This creates basis convergence risk for hedgers.

Example:

• Jan 1: Spot $70, June futures $73.50 (basis +$3.50)
• June 15: Spot $75, June futures $75.00 (basis converges to ~$0)

A hedger short June futures (locked in at $73.50) and long the commodity loses because the commodity rose to $75, and the futures also converged to $75. The hedge was imperfect due to basis.

Basis risk in hedging

Perfect hedging requires the basis to remain constant. But basis is dynamic; it changes with cost-of-carry, interest rates, and convenience yield.

A farmer hedging the fall harvest by selling September grain futures faces basis risk: if the basis narrows unexpectedly, the future value of his grain falls relative to the locked-in futures price.

Profitable basis trades

When basis widens (futures diverge from spot), traders can exploit it:

• Buy spot, sell futures: If basis is wide positive (contango is steep), buy the commodity and sell the far futures contract. The convergence at expiration locks in profit.
• Sell spot, buy futures: If basis is negative (backwardation), short the spot and buy near futures, profiting as basis reverts.

These are called basis trades or cash-and-carry trades.

Basis across different assets

Stock indices: Basis is usually small (storage not applicable) and varies with interest rates and dividend yield.

Commodities: Basis is substantial and varies with storage costs (oil, metals) or seasonal patterns (grains).

Bonds: Basis varies with repo rates and delivery options in the futures contract.

See also