NISM Series XVI - Commodity Derivatives Exam Notes
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Basis= Spot Price - Futures Price
Basis risk is defined as the risk that a futures price will move differently from that of its underlying asset. The best method of eliminating the basis risk is to hold the futures contract till expiry, since the futures and spot prices converge on expiry.
Negative Basis / Contango Market - When the futures price is greater than the spot price, the basis is a negative number.
In Agricultural commodity derivatives, Contango like situation may also arise due to expected quality related issues in goods lying in warehouses or are expected to come into warehouses, which the traders expect that may not be deliverable and may be rejected.
Positive Basis / Backwardation Market - When the futures price is less than the spot price, the basis is a positive number.
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