The spot-futures basis is the difference between a spot or cash price and the price of a specified futures contract, measured at the same observation time. For a commodity business, that difference helps explain why a futures hedge can stabilise a selling price or purchase cost without fixing it exactly.
This page uses the convention
where is the relevant cash price and is the futures quote at time for a contract expiring at . Both must use the same currency and quantity unit. Some sources define basis as futures minus spot, particularly for financial assets; always state the subtraction before interpreting its sign.
Name both prices before subtracting
“Wheat basis” is incomplete without the cash grade, location, delivery terms, observation time and reference futures month. A local cash bid and an exchange futures settlement may differ because of freight, handling, quality or local supply and demand. Stale quotes or incompatible units can also create a misleading apparent spread. CME’s grain-basis explanation describes these physical-market differences.
Consider fictional matching prices, all in USD per commodity unit:
| Observation | Spot | Same futures contract | Basis: spot minus futures |
|---|---|---|---|
| Entry | 100 | 103 | −3 |
| Expiry | 102 | 102 | 0 |
Initially, spot is 3 USD per unit under futures. Moving from −3 to 0 is a strengthening of the basis by 3 USD per unit: under this convention, strengthening means an increase, and weakening means a decrease. Neither word says that both prices rose; here spot rose while futures fell.
Original synthetic observations for one eligible commodity and the same futures contract. Exact equality at expiry is stipulated for the matching settlement benchmark; it is not assumed for every local physical quote.
Convergence refers to cash and futures prices tending toward each other near delivery or expiry. Its economic link depends on the contract’s delivery or settlement mechanism. It does not imply that every local grade or delivery location must have zero basis. Delivery expenses, quality differentials and timing can remain relevant; the CFTC’s discussion of delivery points and grades explains why contract specifications matter.
The hedge leaves a closing-basis term
Suppose a producer will sell one physical unit at the later date and shorts a matching futures exposure at entry. Ignore fees, financing, storage and the interest effects of settlement timing. The effective sale receipt per unit is
In the matching example, the physical sale receives 102, the short futures gains 103 − 102 = 1, and the combined receipt is 103 USD per unit. The futures amount is the cumulative gain from settlement cash flows; it need not arrive on the physical-sale date. Futures are marked to market, so the funding needed along the way is a separate concern.
Now consider an alternative sale at the producer’s different local delivery location, with a final cash quote of 101, while the futures quote remains 102. The local closing basis is −1, so the same short futures gain plus the physical sale produces 102 USD per unit, rather than 103. The contract’s own benchmark can converge while a producer’s local quote retains a differential.
This is the distinction between basis, the observed price difference, and basis risk, uncertainty about that difference when the hedge is closed. In this matched-unit ledger, a stronger closing basis raises a seller’s effective receipt. A buyer hedging a later purchase with long futures instead pays , so a stronger closing basis raises the buyer’s effective cost. Quantity mismatches and different underlying products require further hedge analysis.
The Commodities lesson connects physical specifications and storage to a producer hedge. Its public preview leads to the full lesson, available with a free signed-in account.
A price gap is not a return
The basis compares cash with one futures maturity. Contango and backwardation describe comparisons across delivery dates; one basis observation does not reveal the whole curve.
Nor is a negative basis an automatic arbitrage profit. Buying and carrying physical stock entails financing, storage, delivery and execution costs, and may provide convenience yield. A cost-of-carry analysis must account for those economics. Basis is a quoted price difference, not a funding rate, a futures-only return, or a cash payment made simply for entering a contract.
Sources
- CME Group — Learn about Basis: Grains: cash-minus-futures convention, physical differentials and hedge direction.
- CME Group — Glossary: Basis, Basis Risk and Convergence entries.
- CFTC — Policy Statement on Price Differentials: delivery grades, locations and convergence.
- CME Group — Mark-to-Market: daily settlement gains and losses.
- John C. Hull, Options, Futures, and Other Derivatives, Ninth Global Edition, Pearson 2018, Chapter 3, §3.3, printed pp. 76–79: basis conventions and short- and long-hedge identities.