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Sunanda K. Chavan
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sunandaC
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BASIS - October 8th, 2010

BASIS

The difference between the prevailing spot price of an asset and the futures price is known as the basis, i.e.

Basis = Spot price – Futures price

In a normal market, the spot price is less than the futures price (which includes the full cost-of-carry) and accordingly the basis would be negative. Such a market, in which the basis decided solely by the cost-of-carry, is known as the Contango Market.

Basis can become positive, i.e. the spot price can exceed the futures price only if there are factors other than the cost-of-carry to influence the futures price. In case this happens, then basis become positive and the market under such circumstances is termed as a Backwardation Market or Inverted Market.

Basis will approach zero towards the expiry of the contract, i.e. the spot and futures prices converge as the date of expiry of the contract approaches. The process of the basis approaching zero is called Convergence.
As already explained above, the relationship between futures price and cash price is determined by the cost-of-carry.

However, there might be factors other than cost-of-carry, especially in case of financial futures I which there may be carry returns like dividends, in addition to carrying costs, which may influence this relationship.

The cost-of-carry model in financial futures, thus, is

Futures price = Spot price + Carrying costs – Returns (dividends, etc.)

---------------------------
Example
The price of ACC stocks on 31st December 2000 was Rs. 220 and the futures price on the same stock on the same date, for March 2001 was Rs. 230. Other features of the contract and related information are as follows:

Time of expiration - 3 months (0.25 year)

Borrowing rate - 15% p.a.

Annual Dividend on the stock - 25% payable before 31.03.2001


Face value of the stock - Rs. 10

Based on the above information, the futures price for ACC stock on 31st December 2000 should be:
= 220 + (220 x 0.15 x 0.25) – (0.25 x 10)
= Rs. 225.75

Thus, as per the ‘cost of carry’ criteria, the futures price is Rs. 225.75, which is less than the actual price of Rs. 230 in February 2001. This would give rise to arbitrage opportunities and consequently the two prices will tend to converge.

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Rose Marry
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Re: BASIS - April 15th, 2016

Quote:
Originally Posted by sunandaC View Post
BASIS

The difference between the prevailing spot price of an asset and the futures price is known as the basis, i.e.

Basis = Spot price – Futures price

In a normal market, the spot price is less than the futures price (which includes the full cost-of-carry) and accordingly the basis would be negative. Such a market, in which the basis decided solely by the cost-of-carry, is known as the Contango Market.

Basis can become positive, i.e. the spot price can exceed the futures price only if there are factors other than the cost-of-carry to influence the futures price. In case this happens, then basis become positive and the market under such circumstances is termed as a Backwardation Market or Inverted Market.

Basis will approach zero towards the expiry of the contract, i.e. the spot and futures prices converge as the date of expiry of the contract approaches. The process of the basis approaching zero is called Convergence.
As already explained above, the relationship between futures price and cash price is determined by the cost-of-carry.

However, there might be factors other than cost-of-carry, especially in case of financial futures I which there may be carry returns like dividends, in addition to carrying costs, which may influence this relationship.

The cost-of-carry model in financial futures, thus, is

Futures price = Spot price + Carrying costs – Returns (dividends, etc.)

---------------------------
Example
The price of ACC stocks on 31st December 2000 was Rs. 220 and the futures price on the same stock on the same date, for March 2001 was Rs. 230. Other features of the contract and related information are as follows:

Time of expiration - 3 months (0.25 year)

Borrowing rate - 15% p.a.

Annual Dividend on the stock - 25% payable before 31.03.2001


Face value of the stock - Rs. 10

Based on the above information, the futures price for ACC stock on 31st December 2000 should be:
= 220 + (220 x 0.15 x 0.25) – (0.25 x 10)
= Rs. 225.75

Thus, as per the ‘cost of carry’ criteria, the futures price is Rs. 225.75, which is less than the actual price of Rs. 230 in February 2001. This would give rise to arbitrage opportunities and consequently the two prices will tend to converge.

------------------------------
Hello dear,

Here I am uploading Study on Detecting Spot Price Forecasts In Futures Prices, so please download and check it.
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