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
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