Basis
In derivatives markets, basis is defined as the difference between the spot (cash) price of an asset and the price of the corresponding futures contract for that asset. More broadly, basis captures the relationship between two related but not identical instruments or prices, and its movement over time — known as basis change — is a central source of both risk and profit in hedging and relative value trading.
Key takeaways
- Basis = Spot Price − Futures Price (in commodities) or Futures Price − Spot Price (in financial futures, where the sign convention is sometimes reversed).
- At futures contract expiry, basis converges to zero as futures and spot prices must equalize — this is known as 'convergence.'
- Positive basis (spot > futures) is called 'backwardation'; negative basis (spot < futures) is called 'contango,' and each reflects different supply/demand and cost-of-carry dynamics.
- A hedger who uses futures to offset a spot position is exposed to basis risk — the risk that basis changes unfavorably before the hedge is lifted.
- Basis trading strategies explicitly take positions in the spread between futures and their underlying deliverable, seeking to profit from predictable basis movements near contract expiration.
Explanation
The theoretical basis between a futures contract and its underlying spot asset is determined by the cost-of-carry model. For a financial asset paying no dividends or income, the fair value futures price is: F = S × e^(r × T), where S is the spot price, r is the risk-free rate, and T is time to expiration. Rearranging, basis = S − F = S − S × e^(r × T) = −S × (e^(r × T) − 1), which is negative for positive interest rates — meaning financial futures typically trade above spot (contango), and basis is negative and converges toward zero as T approaches zero.
In commodity markets, the cost-of-carry framework is augmented by storage costs (positive), convenience yield (negative, reflecting the benefit of holding physical inventory), and seasonality. When physical inventory is tight and there is a premium on immediate access to the commodity — as occurs in energy markets during cold snaps or agricultural markets during harvest shortfalls — convenience yield exceeds storage costs and the futures curve inverts, creating backwardation (spot > futures, positive basis). In this environment, long-only commodity investors benefit from positive roll yield as they sell expiring contracts at higher prices and buy new deferred contracts at lower prices.
For practitioners, basis analysis is critical in hedging decisions. A grain elevator that owns physical corn and is short corn futures as a hedge does not face price risk (directional moves in the absolute corn price) but does face basis risk — the risk that the difference between the local cash corn price and the Chicago Board of Trade (CBOT) futures price changes. Local basis reflects local supply and demand conditions, transportation costs to delivery points, and storage availability. If basis widens (local cash falls relative to futures), the elevator loses money on the hedge basis position; if basis narrows, it gains.
In bond markets, the term 'basis' refers specifically to the difference between the yield on a cash bond and the yield implied by the corresponding futures contract — adjusted for the cheapest-to-deliver (CTD) issue and the conversion factor. Basis trading in bond markets involves buying the cash bond and selling futures (or vice versa) and managing the carry, pull-to-par, and delivery optionality embedded in the trade.
Formula
Basis = Spot Price − Futures Price Cost-of-Carry Futures Price: F = S × e^(r+u-y) × T, where u = storage cost rate, y = convenience yield
Example
A U.S. wheat farmer expects to harvest 100,000 bushels of hard red winter wheat in July and wants to lock in a price today (March). CBOT July wheat futures are trading at $6.20/bushel. The local cash price (basis) for the farmer's location is $5.95/bushel, meaning local basis is −$0.25 (cash below futures). The farmer sells 20 CBOT contracts (5,000 bushels each). By harvest in July, CBOT futures have declined to $5.80/bushel and local cash is at $5.65/bushel — basis has narrowed slightly to −$0.15. The farmer sells the physical wheat at $5.65 and buys back the futures at $5.80 (gain of $0.40/bushel on futures). Net selling price: $5.65 + $0.40 = $6.05/bushel, better than if basis had remained constant ($6.20 − $0.25 = $5.95), because basis strengthened by $0.10 in the farmer's favor.
Related terms
Backwardation Basis Risk Board Of Trade Bond Cheapest To Deliver Contango Delivery Embedded Derivative Futures Contract Futures Curve Futures Price Hedging