Basis, in the context of trading and more specifically in futures trading, is a fundamental concept that represents the price difference between a futures contract and the underlying or spot asset, commonly referred to as the cash price. It serves as a crucial indicator for traders, investors, and hedgers in various financial markets.
Basis is calculated as follows:
Basis reflects the economic disparity between the current market price of the underlying asset (cash price) and the agreed-upon price for the same asset at a future date (futures price). The futures price is determined in the futures market, while the cash price is based on the prevailing market conditions for the actual asset.
Basis can provide insights into the efficiency of the market. When the basis is zero or very close to zero, it indicates that the futures market accurately reflects the current cash market conditions and this scenario is often referred to as "cash and carry" or "arbitrage equilibrium."
Traders and investors use basis analysis to identify trading opportunities. For instance, if the basis is positive (cash price exceeds futures price), it may suggest that the market anticipates an increase in the asset's value. Conversely, a negative basis (futures price higher than cash price) could imply expectations of a price decline.
One of the primary purposes of the futures market is to provide a risk management tool for hedging against price fluctuations in the underlying asset. Basis analysis helps market participants determine the optimal timing for hedging activities. When the basis is favorable, it may be a suitable time to hedge positions. Basis is used to determine the best futures contract month in which to place the hedge.
Basis plays a central role in the delivery process of futures contracts. If a futures contract approaches its expiration date and the basis is significantly positive, it may incentivize traders to take delivery of the underlying asset. Conversely, a negative basis may discourage delivery.
In some markets, such as agricultural commodities, basis can be influenced by seasonal factors. For example, the basis for wheat futures might vary depending on the time of year and the crop's harvest cycle.
Basis can also be affected by storage costs for certain commodities. If the cost of storing the physical commodity exceeds the potential benefits of holding a futures contract, it can result in a negative basis.
In cryptocurrency, it can refer to a digital asset designed to have a stable valuation by shrinking and expanding its availability. Basis was known as Basecoin until its sponsor, Intangible Labs, Inc. announced it had raised $133 million in its initiative to make Basis a stable cryptocurrency. Intangible Labs, Inc. stated in an SEC Form D filing that it had issued $125 million in a SAFT. In a statement published on its website on December 13, 2018, Intangible Labs announced that it was returning investor monies and shutting down Basis stating, "Unfortunately, having to apply US securities regulation to the system had a serious negative impact on our ability to launch Basis."
- Futures Glossary. CFTC.
- Basis: The Cash/Futures Price Relationship. Agmanager.info.
- Understanding Basis. Oxfordfutures.com.
- Princeton graduates' crypto-currency wins backing of big U.S. investors. Reuters.
- Introducing Basis, a Stable Cryptocurrency with an Algorithmic Central Bank*. Medium.
- Form D. SEC.
- Letter to Basis Community. Intangible Labs.