What is a Basis Quote
A basis quote is one given on a futures contract which expresses the price as the difference between the price of the futures contract and either another futures contract or the spot price of the underlying commodity.
Used on its own, basis refers to the spread between the delivery price detailed on a futures contract and the spot price of a given commodity.
BREAKING DOWN Basis Quote
A basis quote for a futures contract uses the difference between the price of a contract spot price of the commodity or it can compare to another existing futures contract. Since basis is the spread between the commodity and a contract, it may be calculated using the formula:
- Basis = futures contract price - spot delivery price
As an example, the spot price of a bushel of corn is $3 in January, and the price of a February delivery futures contract on the same product is $3.25, then the basis is $0.25. ($3.25 - $3 = $0.25).
Basis may also appear as a negative value, as in $3 spot corn and a February delivery contract of $2.75, has a basis of -$0.25.
A corn farmer seeking to hedge against the future downward movement in the spot price of corn may decide to offer a futures contract in January. The farmer, concerned that the price of corn would dip below $3, might try to lock in a price of $3.25 per bushel for February delivery. The basis quote for such a contract would be expressed as $0.25 under, as the cash price would be under the contract price.
If the farmer sells their contract, they will then hold a short position and would be subject to basis risk. This risk is that the offsetting, hedge, will move in a direction other than directly opposite. Instead of the price of corn falling, it could rise or remain the same.
Typically, spot prices and future prices will move together, and basis volatility will be relatively low. If, in our example above, the cash price increases above $3.25 per bushel between January and February, the basis of the farmer’s February contract will narrow, and the farmer’s short position will lose value. As this happens, the basis quote on the farmer’s $3.25 February contracts would reflect the tighter spread between the contract and the cash price. This spread would be offset by the spot price which the farmer can receive in February for sales outside of the futures contract. The farmer would, however, eventually be forced to either make delivery on that corn at $3.25 per bushel or to close out the short position by buying an opposite position on the open market.
Movements in basis are affected by many factors, including holding costs, weather events, and geographic variations for contracts offered in different markets.