Death comes to us all. Life's but a walking shadow | It's important to clearly understand how it all works so you can make the best of it.
I'm no expert on basis but this is what I think.
First you need to keep in mind just what a futures price means. The futures price is the price you would receive if you delivered grain to one of several designated delivery points. At the delivery point there is no basis, period. One view of basis is what does it cost (or what will it take) to make grain move to those delivery points during the delivery period. If it cost 35 cents to move a bushel of corn from western Nebraska to the Mississippi river then the basis is the futures price minus 35 cents. Likewise if it cost 50 cents to move corn from the closest delivery point to eastern Pennsylvania then the basis there is +50.
Another view of basis is more global. Suppose the worldwide supply of corn is ample so the market isn't worried about a shortage. In that case traders might put a price of $3.50 on corn however there was a drought in the western corn belt and there is a local shortage. Local producers know there's a local shortage but they also know that it would be prohibitive to move grain from South America to Kansas to feed cattle so they simply say: "our grain is worth more than the world price. If you want it pay up."
And then there is the other situation. It's June you've planted you corn and you'd like to presell some. A grain merchant would like to make sure he has some grain to sell but he'll be taking on some price risk by buying four months before harvest. It's likely that he'll quote you a negative basis because he'll take over you risk for that four months and still promise to pay the current futures price. In this case the basis reflects the time value.
More generally the basis is simply the difference in price between what the current price is at time X & point Y and the price at time X+Z & point Y+W. |
Basis?
