Basis Spread

What is a basis trade?

A basis trade is a trade in which the trader simultaneously purchases (sells) an asset and sells (buys) the futures contract for that asset. Since spot and futures are traded separately, their prices are not guaranteed to be the same at all times. In fact, their prices often diverge and this differential is known as the "basis".

As the future approaches expiration, its price often trends towards the underlying spot price. At expiration, futures contracts require the trader long the contract to purchase the underlying asset at the contract’s predetermined price, guaranteeing that at the futures contract expiry. Therefore, as the futures expiration draws nearer, the basis should approach 0.

If for example, the futures contract is trading at a premium to the underlying spot price, a trader can short this future against the underlying and as the future converges to the spot price at expiration they will collect this difference in basis. Fixed expiry futures will provide a fixed interest rate on this basis trade.

Example

For instance, at the time of writing, the price for the ETH/USD spot is $1719.80, whereas the price for the December 30 expiry futures, ETH-1230, has a price of $1723.50. We define the basis as being the difference between the spot price 1719.80 USD and the futures price 1723.50 USD.

The basis would have a value of $1723.50 - $1719.80 = $3.70. It is easier to compare the basis in percentage terms, in which case we can state the basis percentage would be $3.70 / $1719.80, or 0.215%, achieved by holding for about half of a year; this annualizes to a 0.510% annual return.