What it means
Basis is the difference between what a commodity sells for locally right now and the price of a futures contract for the same commodity. A narrow basis means the local price tracks the benchmark closely, while a wide basis means there is a big gap between them.
The gap can be positive or negative, and traders talk about a "weak" basis when the cash price is unusually low against futures and a "strong" basis when it is unusually high. Several things widen the basis.
Transport bottlenecks, such as a closed river or a shortage of rail wagons, can trap grain in one region and push local prices down. Full storage, a bumper harvest, a quality problem or a sudden local shortage can have the same effect in either direction.
For producers and buyers who hedge, the basis is the part of price risk that a futures contract does not remove. A farmer who sells futures locks in the benchmark price but still faces whatever the basis turns out to be on the day the crop is sold.
This is why hedgers watch basis patterns through the year and often agree a basis contract with the buyer in advance. Finance teams should not treat a wide basis as an error.
It is real economic information about local supply, demand and logistics, and it can last for weeks or months. Forecasts that use only the futures price will overstate or understate real cash flow when the basis is far from its normal range.
The word "wide" says how big the gap is but not why it exists. To judge whether a wide basis is a threat or an opportunity, compare it with the same date in previous years and ask what is driving it.
A wide basis caused by a temporary bottleneck may narrow quickly, whereas one caused by lasting changes in demand may not.
In practice
Real-world examples.
Example
A Midwestern grain farmer hedges next season's crop by selling futures. At harvest, a river closure leaves the local elevator with too much grain and a wide basis, so the farmer receives far less than the futures price and the hedge covers only part of the loss.
Example
A food manufacturer buys wheat for flour production and uses futures to fix its benchmark cost. A regional shortage pushes local cash prices well above futures, and the finance team has to budget for a larger delivery premium than planned.
Example
A natural gas trader sees that gas at one regional hub sells at a deep discount to the national benchmark because pipeline capacity is full. She buys the local gas and sells futures, aiming to profit if the basis narrows when capacity is added.
Formula
Calculation
Basis = Local cash price - Futures price
Suppose December corn futures trade at $4.80 per bushel, and a grain elevator in a remote region is bidding $4.20 for corn today. The basis is 4.20 - 4.80 = -$0.60 per bushel. In a normal year that location's basis is around -$0.25, so the basis is $0.35 wider than usual. On a harvest of 100,000 bushels, the extra widening costs the farmer 100,000 x 0.35 = $35,000 compared with a normal year, even though the futures price is unchanged.Case study
Seen in the real world.
Prairie Gold Cooperative is a fictional grain cooperative with 2,000 farmer members. In an illustrative bumper-harvest year, the nearby rail network fell short of wagons, and the cooperative's basis widened from its usual -$0.30 to -$0.80 per bushel. Members who had hedged with futures found their benchmark gain was largely cancelled by a weaker local price.
The finance manager responded by adding basis analysis to the cooperative's monthly reports. She also negotiated forward basis contracts with a buyer for the next season, fixing the discount in advance for a portion of the crop. The outcome was a more predictable cash flow, even though the cooperative gave up the chance of gain if the basis later narrowed.
Watch out
Common mistakes.
- Believing that a futures hedge removes all price risk, when basis risk remains and can be large in a wide-basis year.
- Using the futures price alone to forecast cash receipts, which ignores the local gap between cash and futures.
- Assuming a wide basis always means a negative or weak basis, when the gap can also be unusually positive when local supply is short.
Questions
People also ask.
What counts as a wide basis?
There is no fixed number, so a basis is wide when it is much larger than the normal range for that place and time of year.
Why does basis usually narrow near contract expiry?
As the delivery date approaches, the futures contract and the cash market must converge, because they describe the same commodity at the same time.
Can a company profit from a wide basis?
Yes, traders and storage owners sometimes buy cash and sell futures to capture a narrowing, but it carries storage, financing and timing risk.
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