Futures Basis: Spot vs. Futures Pricing & Arbitrage
Cost of carry models, convenience yields, and risk-free institutional cash-and-carry arbitrage mechanics.
1. What Is the Futures Basis?
In derivatives markets, the Futures Basis represents the arithmetic difference between the current cash spot price of an asset and the price of its corresponding futures contract:
2. The Cost of Carry Model
The fair theoretical relationship between spot and futures prices is determined by the Cost of Carry Model:
Where $S$ is the spot price, $r$ is the risk-free financing interest rate, $u$ is the physical storage and insurance cost, and $y$ is the convenience yield or dividend yield.
3. Cash-and-Carry Arbitrage
Whenever the market futures price diverges from its theoretical cost of carry fair value, institutional proprietary trading desks execute risk-free Cash-and-Carry Arbitrage (buying the cheap spot asset and shorting the overpriced future, or vice versa), forcing the basis back into alignment as contract expiration approaches.