The basis spread is defined as the difference between a commodity’s futures price and that commodity’s prevailing  cash price.

                                                                     Basis Spread = Cash Price – Futures Price

Clean historical basis data extending back to 1974 is available for download and can be analyzed to identify seasonality and opportune periods for producers and hedgers to initiate and lift hedges. Similar to other spreads basis spread strategies can be both long and short. For example, if a trader buys cash corn and hedges it by selling an equal amount of corn on the futures market the trader is ‘long’ the basis and is seeking protection against falling cash market prices. Conversely when a crusher sells grain and offsets this trade with the purchase of grain futures the crusher is ‘short’ the basis and seeks protection against rising cash market prices. If cash prices are below futures prices then the basis is deemed ‘under’ and when cash prices are above the futures price the basis is deemed as ‘over’ or ‘premium’. 

If a farmer initiates a ‘long basis’ (long cash-short futures) position when the September Wheat futures contract Is trading at $5.80 and the cash price is at $5.50 then the cash price is 30 cents ‘under’ September. When the long wheat basis position is closed out, if the differential between cash and futures is 30 cents under, then the basis hedge will have performed exactly as expected. If the basis is 40 cents under, the basis position will have lost 10 cents and if the basis is 10 cents under, then the basis position will have made 20 cents profit. quantitative analysis of historical basis data can be an important aid for hedgers as it can help them more precisely determine when to initiate or put on a hedge and lift or exit a hedge using futures contracts.

Basis spreads can be applied to most exchange-traded commodities where a cash price is available, but they are most prevalent in contracts that have physical delivery. For physical delivery contracts the futures price and cash price tend to converge to zero or near zero at contract expiration or delivery date. This phenomenon is called convergence.

There are a number of factors that contribute to fluctuations in the basis spread in the weeks and months prior to contract expiry. These include: transportation costs, storage costs, insurance costs, supply and demand expectations, weather and financing costs. Transportation costs are incurred when shipping a commodity to market. Storage costs and financing costs change constantly throughout the year. Crops offered for sale at harvest time typically  incur little or no storage or financing costs but as the crop year progresses storage and financing costs increase the longer the commodity is stored and cash prices tend to rise to reflect these cost increases. Supply and demand factors also influence the basis spread. Farmers selling around harvest time will depress the cash price and the basis is historically the widest around harvest time. As selling pressure abates into spring planting the cash price tends to strengthen and the basis will narrow. Changes in export demand during the marketing year can also exert influence on basis spreads.