Basis is the difference between the cash price (spot price) of a commodity and the futures price. You are focused on futures trading with the key concept being forward rate parity (FRP) — the difference in the price now compared to the price in the future.
Basis = Cash Price - Futures Price.
How Basis Works in Futures Trading
Basis is one of the basic futures trading concepts. It is an important indicator to traders and investors, symbolizing market conditions, including forces of supply and demand, storage expenses, and interest rates.
Let us assume, the cash price of wheat is ₹ 2,000 per quinta, and the wheat futures price is ₹2,050, then the basis will be -₹50 (₹2,000 – ₹2,050). Over time, the basis can change due to variables such as supply and demand factors, storage costs, and market expectations.
Hedgers and traders observe the basis to assess their positions and look for arbitrage opportunities. A tightening basis signals convergence of cash and futures prices, while widening indicates divergence.
The Basics of Basis Trading
Here’s what you need to understand about basis trading:
- Basis = Cash price - Futures price Hedging: Basis assists traders in determining whether a futures contract provides a genuine hedge against price specificities.
- Market Indicator: When the basis moves up or down, it means there are changes in supply and demand, storage costs and market expectations.
- Next Month Contract: The basis is generally calculated based on the price of the nearest futures contract month, unless specified otherwise.
Why Basis Trading Matters
Whether you’re a hedger trying to hedge away price movements or a trader wanting to take advantage of arbitrage opportunities, understanding Basis is crucial for success. Get started with futures trading on Religare Online, a reliable platform that offers the tools and resources you need to analyze the market and succeed as an investor in stock futures.