Basis: Spot vs Futures Price Difference Explained

Key Takeaways

• Basis equals cash price minus futures price; a negative basis (contango) is common when storage and financing costs exceed the convenience yield of holding the physical commodity.
• The CFTC notes convergence at expiration typically lands within 10 cents per bushel, not exactly at zero, due to transaction, storage, and opportunity costs.
• Traders often treat basis as a directional forecast when it is only a current measurement of the relationship between cash and futures prices.
• Hedgers watch local basis to judge whether their physical position is gaining or losing relative to the futures hedge, which determines actual net revenue.

What It Is

The CFTC defines basis as "the difference between the spot or cash price of a commodity and the price of the nearest futures contract for the same or a related commodity." The standard sign convention is:

basis = cash price - futures price

A positive basis means the cash market is trading above futures. A negative basis (the more common case for most commodities, in a normal contango market) means the cash market is trading below futures. The same term is used for financial instruments: the Treasury cash-futures basis is the cash bond price minus the futures price adjusted for conversion factors.

Basis is not a prediction. It is a measurement of the current relationship between two prices for closely linked instruments. It moves every day as supply, demand, storage, and transportation conditions shift.

The Intuition

Cash prices and futures prices describe slightly different things. The cash price is what a specific grade of a commodity costs at a specific location today. The futures price is what a standardized contract for a standardized grade costs for delivery in a future month at a designated delivery point. Because grades, locations, and timing differ, the two prices are not going to be identical except at the delivery event.

What anchors them is convergence. As the futures contract approaches expiration, arbitrage forces narrow the gap between cash and futures. At expiry, if the prices differ by more than transportation and handling costs, someone will buy the cheap side and sell the expensive side. That trade keeps the two from drifting far apart.

The CFTC Agricultural Markets subcommittee has noted that convergence does not necessarily mean a strict zero basis. Rather, it is "a zone of convergence, commonly less than 10 cents per bushel, due to transaction, storage, and interest opportunity costs." Perfect convergence is rare, but a persistent failure to converge is a warning sign about delivery mechanics.

How It Works

Between now and expiration, basis reflects the cost of carry and any location or quality adjustments. In a storable commodity with cheap storage:

futures ~ spot + storage cost + financing cost - convenience yield
basis   = spot - futures
        ~ -(storage + financing - convenience)

When storage and financing dominate, basis is negative and futures trade above spot. This is a contango market. When the convenience yield of holding the physical commodity today dominates, basis can flip positive and futures trade below spot. That is backwardation. For more on these regimes, see Contango vs Backwardation.

A grain elevator tracks local cash corn prices against the CBOT corn futures. That local basis also includes the cost of moving corn from the local silo to the CBOT delivery point and a quality differential relative to the deliverable grade. A narrowing basis means local cash is strengthening relative to futures, which often reflects tight local inventories.

Worked Example

Consider a U.S. Treasury cash-futures basis trade. A five-year Treasury note cash security trades at 99.50, and the related five-year note futures contract trades at 109.60 with a conversion factor of 0.9079 that adjusts for differences between the cash security and the notional bond underlying the futures contract.

cash price                = 99.50
futures price * conv fac  = 109.60 * 0.9079 = 99.51
basis                     = 99.50 - 99.51 = -0.01

The cash and futures are almost perfectly aligned. If the basis widened to, say, negative 0.15, a basis trader could buy the deliverable cash bond and sell the futures, locking in the spread. Near delivery the two prices must converge, so the trade captures the gap. This exact arbitrage is the mechanism the CFTC describes in its research on the Treasury cash-futures basis trade.

For commodities, the same arithmetic applies. If cash corn in Iowa is at 4.50 per bushel and the nearby CBOT corn futures is at 4.60, the local basis is minus 10 cents. As expiration nears, the futures contract's price should drift toward the cash price in the delivery zone, and the basis should narrow toward zero plus local adjustment costs.

Common Mistakes

1. Treating basis as a forecast. Basis describes the current relationship between cash and futures. It does not tell you which way either price is going.

2. Forgetting the convergence zone. Basis does not have to hit exactly zero at expiration. A persistent non-zero basis around delivery often just reflects storage, financing, or location costs, not a broken market.

3. Comparing cash and futures without adjusting for grade or location. A basis that looks distorted often becomes normal once you account for quality differentials or transportation between the cash market and the delivery point.

4. Assuming the sign convention is universal. Some trade desks define basis as futures minus cash. Always check which convention a chart or report is using before interpreting the number.

Frequently Asked Questions

Q: What is basis spot vs futures in simple terms? Basis is the arithmetic difference between the current cash market price of a commodity or security and the price of the nearest related futures contract. It changes every day as supply, storage, and financing conditions shift in each market.

Q: How does basis affect investment decisions? Hedgers use basis to evaluate whether a futures position provides effective price protection. If local basis is persistently negative, a grain elevator locking in futures prices earns less than expected when the physical sale occurs. Tracking basis is how commercial hedgers measure the quality of their hedge.

Q: What is a real-world example of basis? If Iowa cash corn trades at $4.50 per bushel and the nearby CBOT corn futures trades at $4.60, the local basis is minus $0.10. As expiration approaches, arbitrage forces should narrow that gap toward the delivery-zone cost structure, typically within a few cents.

Q: How can investors use basis in a portfolio context? Basis risk, the risk that the cash-futures spread moves unfavorably, is a core consideration for any commodity or Treasury hedge. A basis trade that buys the cash bond and sells the futures is an explicit bet on basis convergence, a strategy used extensively by fixed-income arbitrageurs.

Q: How is basis different from contango and backwardation? Contango and backwardation describe the shape of the entire futures forward curve across delivery dates. Basis is a single-point comparison between today's cash market and the nearest futures contract. Basis is what producers and hedgers manage day to day; contango and backwardation describe the broader market structure.

Sources

1. CFTC. "Futures Glossary." https://www.cftc.gov/LearnAndProtect/AdvisoriesAndArticles/CFTCGlossary/index.htm
2. CFTC. "Report of the Subcommittee on Convergence in Agricultural Commodity Markets." https://www.cftc.gov/sites/default/files/idc/groups/public/@aboutcftc/documents/file/reportofthesubcommitteeonconve.pdf
3. CME Group. "What is Contango and Backwardation." https://www.cmegroup.com/education/courses/introduction-to-ferrous-metals/what-is-contango-and-backwardation.html

Disclaimer

This article is educational content only and is not financial advice. Nothing here is a recommendation to buy, sell, or hold any security. Consult a licensed advisor before making investment decisions.