What is Basis?
In the financial markets, "basis" is the term used to describe the difference between the spot price and the futures price. It indicates the price of a futures contract relative to the spot market price.
The existence of basis is due to futures contracts having specific expiration dates, while spot transactions occur on the spot. Therefore, the basis can be seen as the time difference between the futures market and the spot market.
How is Basis Calculated?
The method for calculating basis depends on the specific market and type of commodity. Here is a common method for calculating basis, applicable to commodities like agricultural products, energy, and metals:
- First, determine the spot price and the futures price. The spot price is the real-time trading price of a commodity on the spot market, while the futures price is determined through futures contracts on an exchange.
- Then, subtract the spot price from the futures price to get the difference.
Basis = Futures Price - Spot Price
If the futures price is higher than the spot price, the basis is positive; if the futures price is lower than the spot price, the basis is negative. - Finally, the basis is usually measured in monetary units or commodity units (for example, dollars/barrel, dollars/ton, etc.), depending on the traded commodity.
It is important to note that the calculation of basis can also be affected by other factors, such as exchange rules, contract provisions, delivery places, and times. Different markets and commodities may have different calculation methods and rules; therefore, the basis calculation method should be determined according to the specific market and commodity requirements in practice.
What do Strengthening and Weakening Basis Mean?
Strengthening and weakening basis are terms related to the difference between futures prices and spot prices, used to describe the trend of changes in basis.
- Strengthening Basis: A strengthening basis means that the futures price rises relative to the spot price, i.e., the basis becomes larger or positive. This indicates that the futures market's expectations for future supply-demand conditions or other factors become more optimistic, resulting in futures prices higher than spot prices. A strengthening basis may suggest the market's optimistic expectations for future supply reduction, demand increase, or other factors.
- Weakening Basis: A weakening basis means that the futures price declines relative to the spot price, i.e., the basis becomes smaller or negative. This indicates that the futures market's expectations for future supply-demand conditions or other factors become more pessimistic, leading to futures prices lower than spot prices. A weakening basis may imply the market's pessimistic expectations for future supply increase, demand decrease, or other factors.
Changes in strengthening or weakening basis can be caused by various factors, such as market supply-demand relations, seasonal factors, political factors, weather conditions, production situations, etc. These changes in factors can affect the relative prices of the futures and spot markets and are reflected in the basis. Investors and analysts often focus on the changes in basis to understand market trends and price expectations, serving as a reference for decision-making.
