Short the Basis

Posted in Finance, Accounting and Economics Terms, Total Reads: 134

Definition: Short the Basis

Short the Basis is a hedging technique in futures contracts whereby investor hedge their risk by taking in the short position in the commodity and a long position in the futures contract.

Short the Basis technique is used by an investor when he wants to hedge against the price risk of the commodity. Therefore he shorts his position in the commodity which means he sells the commodity with the intuition that the price of the commodity will fall. And he also longs his position in the futures contract of that commodity implying that he buys the futures contract of the same commodity to fix in the futures price of the commodity to again prevent from the rise in the price of the commodity which he has to buy in the future. So he hedges against the rise in the price of the commodity. In that manner the short position of the hedger in the commodity is hedged against the long position he has taken on futures. Long the basis is the opposite position than short the basis. The investor in long the basis will short the futures position and long their commodity position. Short the basis is adopted when the basis is weaki.e. when the demand is weak and cash prices are lower than the relative futures prices and long the basis is adopted when the basis is strong.

For Example: If an investor wants to buy wheat. Suppose the current price of wheat on the market is $20. If the futures price of the wheat is $15, the investor anticipating his demand after two months buys the necessary amount of wheat futures at $15 to prevent the potential loss from the rise in price of wheat after two months. Thus he longs his position in the wheat futures. Also he sells the current amount of wheat to gain if the price of the wheat instead falls in the future which he can buy then at that lower price. Thus his long position and short position are hedged against each other minimizing the losses for the investor.

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