Definition
The term basis trading refers to an arbitrage strategy used by investors to profit from the mispricing of two related securities. The arbitrager believes that as the mispricing of the securities experience a correction over time, there will be a gain on one side of the trade that will more than offset the loss on the other side of the trade.
Calculation
Trade Basis = Cash Price of a Security - Futures Price of a Security
Explanation
When an investor attempts to profit from a very small basis change in price over time, the approach is referred to as basis trading. Typically, the strategy involves an investor taking opposing long (buy) and short (sell) positions in the two securities. Since the investor is executing the trade based on a relatively small basis change in price, the transaction normally involves some form of leverage too.
For example, there may be mispricing of a security relative to its futures contract. As the value of the security and its futures contract converge over time, the trader can profit if the total purchase price of the security, less all of the associated fees and carrying cost, is greater than the security's futures price.
Related Terms
The term basis point refers to a unit of measure equal to one one-hundredth of one percent. Basis points are a common unit of measure in the financial and investing fields of work.
Moneyzine EditorNovember 6th, 2024
The term basis refers to the total cost of a security, including commissions, expenses, and fees. Basis can also refer to the difference between the spot price of a commodity and its futures price, as well as the after-tax balance of an IRA.Moneyzine EditorNovember 6th, 2024
