Understanding Basis Trading: A Strategy for Arbitrage in the Futures Market

Introduction

Basis trading is a popular strategy among traders, particularly in the futures market. It involves taking advantage of the price difference between a futures contract and the underlying asset, known as the “basis.” By understanding and effectively implementing this strategy, traders can potentially lock in profits with relatively low risk. This article will delve into the mechanics of basis trading, its benefits, risks, and how it works in practice.

What is Basis Trading?

Basis trading refers to the practice of exploiting the difference between the spot price of an asset (the current market price) and its corresponding futures price. This difference is known as the “basis.” The basis can be either positive or negative, depending on whether the futures price is higher or lower than the spot price.

Positive Basis: When the futures price is higher than the spot price.
Negative Basis: When the futures price is lower than the spot price.