What is the 'Basis Grade'

The basis grade is the minimum accepted standard that a deliverable commodity must meet for use as the actual asset of a futures contract. This grading is also known as par grade or contract grade. 

Basis grade is vital for trading in futures and to maintain uniformity within the market.

BREAKING DOWN 'Basis Grade'

As the name implies, the basis grade establishes a baseline from which other variations of the same product or material compare. Products failing to meet this established basis grade, are unacceptable and have the risk of rejection. Since basis grade is the minimum tolerable accepted standard, ideally the exchanged commodity would exceed the criteria. Products of a higher quality which exceed the basis grade command a higher value and justify better exchange terms.

Commodities such as oil and grains may vary drastically in quality. For example, the setting of the basis grade for a crude futures contracts is according to the specific levels of hydrogen and sulfur contained in the oil.

A grading certificate issued by a qualified inspector or an approved grading panel will evaluate and document the grade of a particular commodity. Other official documentation that confirms the products meet the required specifications may also suffice.

Differentials and Basis Grades

Significant deviations from the basis level grade would result in differentials. A differential is the value or degree of adjustment to the category of deliverables, or to their location, as permitted by a futures contract. Differentials include any modifications to the futures contract. 

Futures contracts have standardization concerning the quality and quantity of a given commodity. Because of this, the futures price is representative of a typical range of conditions of the given commodity, and therefore is an average price. If the assessed merchandise is determined to be of better quality and rates above the basis grade, it could command a premium rate. Conversely, products which fail to meet at least the standards set by the basis grade may be unacceptable.

Some futures contracts allow for differentials, while others do not. If permitted, the contacts would typically allow the short position to take the differential. The terms of the contract identify differentials, basis grade, and other conditions related to quality, premiums, or penalties and are fixed conditions on most exchanges.

RELATED TERMS
  1. Deliverable Grades

    Deliverable grades, are the grades or standards of a commodity ...
  2. B3/B-

    B3/B- denotes a letter grade ratings agencies assign to high ...
  3. In Sight

    In sight commodities are those held for delivery at a storage ...
  4. Investment Grade

    Investment grade refers to bonds that carry low to medium credit ...
  5. Default Risk

    Default risk is the event in which companies or individuals will ...
  6. A-Credit

    A-Credit is a high grade a lender can assign to a borrower when ...
Related Articles
  1. Financial Advisor

    Top 5 Corporate Bond Mutual Funds (DEECX, FCBFX)

    Learn about the top five mutual funds that invest in corporate bonds that have investment grade quality and speculative credit ratings.
  2. Investing

    Fallen Angel Bonds and Rising Stars: Risks and Opportunities

    Junk bonds can be an attractive option for private and institutional investors chasing returns.
  3. Investing

    Commodities trading: An overview

    Trading commodities can seem challenging to a novice trader but we break it down for you. Learn more about the history of commodities, the types of commodities, and how to invest in them.
  4. Investing

    Investing in Crude Oil Futures: The Risks and Rewards

    Learn about the risks and rewards of trading oil futures contracts. Read about a few strategies to limit the risk in trading oil futures contracts.
  5. Trading

    Beginner's Guide To Trading Futures

    An in-depth look into what futures are, and how you can build a solid base to begin trading them.
  6. Investing

    All About Liquid Commodities

    You might hear 'liquid commodities' and think of an auction, but they're actually a high-volume, fast paced financial product suitable for day traders.
  7. Insights

    Platts Brent Crude Pricing Faces Overhaul

    Norway's Troll crude oil is the latest addition to the Brent pricing basket.
  8. Insights

    Does A Junk Rating Reflect Russia's Fundamentals?

    Moody’s, like other credit rating agencies, has downgraded Russia’s sovereign debt rating to non-investment grade, but does this reflect Russia's economy?
RELATED FAQS
  1. Why is product differentiation important in today's financial climate?

    Learn the importance of product differentiation and how businesses today are utilizing it to set themselves apart from the ... Read Answer >>
  2. How is the price of a derivative determined?

    Learn how different types of derivatives are priced, including how futures contracts are valued and the Black-Scholes option ... Read Answer >>
Trading Center