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The difference between the local spot price (cash price) and the relevant futures price of a commodity is called the commodity basis.
The spot price of a commodity is the prevailing cash price in the market. The futures price is a representation of the market opinion of the spot price of the commodity on a later date.
Basis is used by investors to gauge the profitability of delivery of cash or the actual, and they also use it to search for arbitrage opportunities.
The basis can be positive or negative.
A positive basis is said to be “over” as the cash price is higher than the futures price.
A negative basis is said to be ‘under” as the cash price is lower than the futures price.
Whether the market is in Contango or Backwardation, as the futures contract approaches the expiry date, the spot and future prices converge.
The basis depends on the local spot market price and so it reflects the local market conditions.
Basis is affected by the following factors: Local supply and demand, storage costs and profit margins.
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