Basis trading

Basis trading is a market-neutral arbitrage strategy that exploits the price difference between a price of an asset and its corresponding future market price. This difference is known as a 'basis' where the trader will profit from price discrepancies. Basis trading is also called the 'cash-and-carry trade'.

Definition of basis

In finance, the basis typically refers to the difference between the spot price of an asset and the price of a related futures contract:

Basis = Spot price − Futures price

The spot price and future prices often differ due to multiple factors including interest rates, and supply and demand.

Types of basis trading

• Long position: Buying and owning an asset with the expectation that its value will increase in the future.

• Short position: Selling an asset with the expectation that its price will decline and intending to repurchase it later at a lower price.

Advantages and disadvantages

Advantages to using basis trading include:

• Generating potential steady profit from a volatile market.
• Provides price security for producers, consumers, and traders.
• Protection against price swings.

While the risk that might occur are:

• Complex trading environment for beginners.
• Thinly traded markets can have liquidity risks.
• Leverage misuse without proper risk management.

See also

• Arbitrage
• Futures contract
• Basis swap
• Derivative (finance)
• Repo market

References