Wide Basis
Candlefocus EditorThe basis refers to the difference between the spot price of an asset and the futures price for a given contract on the same asset. In comparing these two, the market might see an unusually large spread in prices, indicating a wide basis. This could present itself as a case in which the spot price is higher than the futures price, or vice versa, though most wide bases occur when spot price is higher. When this is the case, the market is said to be in a state of contango.
In either a contango or backwardation market, positions involving the generally higher spot price and lower futures price can be taken up to generate a profit. This could involve the buying and selling of both the spot contracts and futures contracts, or the option spreads or other related derivatives.
The size of the basis between spot and futures prices can and does change over time, typically reducing as the futures contract comes closer to its expiration date. Any gap that remains just before expiration will likely present a great opportunity to exploit arbitrage profits.
However, it is also important to be aware of the potential risks associated with such market conditions. A wide basis suggests a lack of liquidity in the market, as well as potential carry costs, and these would both need to be taken into consideration when trading in such a situation. In addition, if the basis begins to narrow as the time of expiration grows close, traders should be aware of the potential of a sudden switch in the market sentiment, which could cause the position to become unprofitable.
Ultimately, a wide basis in the market is a potentially rewarding trading opportunity, with the potential for good returns. However, to be successful in such a situation it is important for traders to ensure that they understand the risk and opportunities associated with the situation, and to monitor the basis as it narrows towards expiration.