The Basis Trading Strategy is a market-neutral approach that exploits the difference—known as the basis—between the spot price and futures price of an asset. Widely used in commodities and financial futures markets, basis trading allows traders to profit from pricing inefficiencies while maintaining minimal directional risk.

In currency, index, or commodity markets, this strategy is especially relevant for hedgers, arbitrageurs, and sophisticated speculators, particularly during periods of high volatility or interest rate divergence.

What Is Basis in Trading?

Basis = Spot Price − Futures Price

• A positive basis means spot price is higher than futures (backwardation)
• A negative basis means futures price is higher than spot (contango)

The basis fluctuates over time due to:

• Interest rates
• Cost of carry (storage, insurance, financing)
• Supply/demand imbalances
• Time to expiry

Strategy Objective

• Capture the convergence between spot and futures prices
• Profit from inefficiencies or anomalies in forward pricing
• Maintain a hedged, market-neutral position
• Use for arbitrage, income generation, or risk management

Types of Basis Trades

1. Convergence Trade (Classic Basis Trade)

• Buy spot, sell futures when futures are overpriced
• Hold until expiry, when prices converge
• Profit = difference between futures and spot, minus carry costs

2. Reverse Basis Trade

• Sell spot, buy futures when futures are underpriced
• Used during backwardation
• Rare in forex but possible in commodities or illiquid conditions

3. Calendar Basis Trade

• Involves spreads between near and far-month futures
• Exploits changes in curve shape over time (contango/flat/backwardation shifts)

Step-by-Step Basis Trading Setup

Step 1: Identify the Basis

• Spot price vs nearest futures contract (e.g. Gold, EUR/USD, Oil)
• Use futures exchange data or broker platforms
• Calculate: Basis = Spot − Futures

Step 2: Analyse the Basis Deviation

• Compare current basis to historical norms
• Spot significant deviation (e.g. excessive contango or backwardation)
• Confirm with macro context (interest rates, storage, demand)

Step 3: Construct the Position

• In positive basis (futures cheap):
  • Buy spot, sell futures
• In negative basis (futures rich):
  • Sell spot, buy futures

Ensure both legs are equal in size and matched in exposure.

Step 4: Hold for Convergence

• Futures and spot prices naturally converge as expiry approaches
• Monitor basis contraction over time
• Exit before or at expiry depending on delivery preferences

Step 5: Exit Both Legs Simultaneously

• Close both spot and futures positions once target convergence achieved
• Lock in profit from basis narrowing

Example: EUR/USD Basis Trade

• Spot: 1.0845
• 3-month futures: 1.0905
• Basis = –60 pips (futures overpriced)
• Sell futures @ 1.0905, buy spot @ 1.0845
• Basis narrows to –10 pips = 50 pip profit (excluding carry costs)

Applications in Other Markets

• Gold: Frequently trades in contango
• Crude Oil: Prone to large backwardation swings
• Bitcoin: Popular basis trades on Binance or CME futures
• Equity Indexes (e.g. S&P 500): Institutional traders arbitrage cash-futures discrepancies

Advantages of Basis Trading

• Market-neutral exposure
• Ideal for hedging or arbitrage strategies
• Profit from inefficiencies, not direction
• Often uses lower margin due to hedge structure
• Valuable in high-interest or volatile markets

Risks and Considerations

• Basis risk: convergence may be delayed or reverse
• Financing costs and rollover fees can reduce profits
• Liquidity risk near expiry
• In spot-futures arbitrage, access to both markets is required
• Regulatory and tax implications depending on asset class

Best Platforms and Tools

• CME, ICE, Binance Futures, Interactive Brokers
• Spread charting tools like TradingView, Sierra Chart
• Basis calculators on broker terminals or spreadsheets
• Economic calendars for interest rate and inflation monitoring

Conclusion

The Basis Trading Strategy is a high-precision, low-risk technique for capturing price convergence between spot and futures markets. Used correctly, it provides an excellent vehicle for arbitrage, passive income, and hedging, particularly when markets become mispriced due to volatility, funding pressures, or macroeconomic events.

To master basis trading and other institutional futures strategies, enrol in our advanced Trading Courses and learn how to execute, size, and manage these trades like a professional.