Definition
Basis (Futures)
Basis is the difference between the futures price and the spot price of the underlying, reflecting the cost of carry and market expectations, and it converges to zero as the contract approaches expiry.
For Indian index and stock futures, the basis is typically positive (contango) because the cost of carry exceeds expected dividends, though it can turn negative around dividend dates or in bearish conditions (backwardation). Watching the basis helps traders gauge financing demand and sentiment.
Because the basis must converge to zero at expiry, cash-futures and index arbitrageurs trade any deviation from fair value, profiting as the gap closes. A persistently wide basis points to constraints on arbitrage, such as limited shorting via SLB or high financing costs.
Related terms
- Securities Lending and Borrowing (SLB)Securities Lending and Borrowing is a regulated mechanism that lets investors lend their shares for a fee to borrowers who need them, typically to facilitate short selling or settlement.
- Index ArbitrageIndex arbitrage exploits price differences between an index's futures and the basket of its underlying stocks (or an ETF), buying the cheaper and selling the dearer to capture the convergence.
- Cash-Futures ArbitrageCash-futures arbitrage profits from the gap between a stock's cash price and its futures price relative to fair value, capturing the cost-of-carry by holding the cash position against an offsetting futures position.
- Cost of CarryCost of carry is the net cost of holding an asset to a future date, comprising financing cost less any income, and it determines the fair-value difference between a futures price and the underlying spot price.
Plain-English explainer from The Dispatch Investors Encyclopedia. General information, not financial advice.