Basis

Basis is usually calculated as the spot price minus the futures price, although some markets use the opposite convention. It reflects factors such as storage costs, interest rates, income from the asset and local supply and demand.

For example, if gold trades at 1,900 per ounce in the spot market and a futures contract for delivery in six months trades at 1,920, the basis is minus 20.

As a futures contract approaches expiry, its price usually moves towards the spot price, so the basis narrows towards zero. This process is called convergence.

Basis is crucial for hedgers. A farmer hedging a wheat crop with futures may find that the local cash price for their wheat and the futures price do not move exactly together, because of differences in location, quality or timing. Changes in basis therefore affect how well a hedge works, which creates basis risk. The word basis has other meanings in finance, such as cost basis for tax.