GlossaryAdvanced
Basis Risk
The risk that the price relationship (the basis) between a hedge and the position it's meant to hedge doesn't move exactly as expected.
Basis risk is the risk that the price relationship — the "basis" — between a hedging instrument (such as a futures contract) and the actual position it's meant to hedge doesn't move exactly as expected, leaving the hedge imperfect even if it's directionally correct.
A cash-and-carry trade (see Kaavon's "Cash-and-Carry Trade" glossary definition) is exposed to basis risk specifically: its profit depends on the spot-futures basis actually converging as expected by expiry, which isn't mathematically guaranteed to happen smoothly or on schedule.
Examples
- A trader hedging spot exposure with futures still carries basis risk, since the futures price and spot price aren't guaranteed to move in perfect lockstep.
- Basis risk is what makes a cash-and-carry trade's profit genuinely uncertain, rather than a mathematically guaranteed arbitrage.