Basis

Reviewed by Vineeth | Updated on Aug 26, 2020

Definition

The term ‘basis’ has numerous meanings in finance. However, it generally points to the difference between the expenses and price in a transaction while computing taxes. This kind of usage is generally referred to as ‘tax basis’ or ‘cost basis’. This is mostly used while calculating capital gains when filing income tax.

Another definition of ‘basis’ is the difference between the relative price of a futures contract and the sport price of a deliverable commodity which has the shortest span to maturity. Basis can also be used in referring to transactions of securities. A particular security’s basis is defined as its purchase price post accounting for other expenses such as commissions.

Understanding Basis

The basis is also defined as the difference between the spot price of a security and its relative price of the futures contract, which has the shortest maturity period. Basis can be used to point to the variation between the derivative futures contract and the corresponding spot price of a given security. The basis is vital as it has tax implications and represents the price connected to a product.

Basis in Futures Market

Basis, in the futures market, is the price difference between the futures price and the cash price of the commodity. The basis is a fundamental idea for the traders and folio managers as this correlation among cash and futures price will affect the cost of the contracts being used as a hedge. The basis may not always be accurate as there are differences among the relative and spot prices until the contract of the shortest expires.

Apart from the variations resulting due to the difference in time among the expiry of spot commodity and futures contract, location of delivery, quality of the product, and the goods can also differ. Generally, the basis is made use of by the investors to measure revenues and the profitability of cash delivery or the goods and is made use of while in pursuit of opportunities for arbitrage.