Basis Risk
Basis risk is the risk that a hedge doesn't move exactly opposite to the position it protects, because the gap between the hedge's price and the asset's price changes. It means even a well-planned hedge can leave some profit or loss.
A farmer sells corn futures to lock in a price. At harvest, local corn prices fall more than the futures price did, and the hedge covers only part of the loss. That leftover gap is basis risk. Every hedger who uses futures or a related asset faces it. This entry explains what the basis is, why it changes and how to manage the risk.
- Category
- Risk Management
- Reading time
- 4 min
- Also called
- Hedge mismatch, Basis risk in hedging
- Updated
Basis risk in plain words
Basis risk is the risk a trader takes when hedging a position with an opposite position in a derivative such as a futures contract.1
If spot gold is $1,190 and the June futures price is $1,195, the basis is $5; basis risk is the chance that this gap shifts and weakens the hedge.1
Hedging doesn't guarantee no loss; it aims to offset losses with gains elsewhere.2
How basis risk arises, step by step
Hold an exposure
E.g. physical crop or fuel.
Hedge with a related contract
Usually futures. See Futures Contract.
Basis = spot − futures
See Basis.
Basis changes
Local supply, quality, timing.
Hedge is imperfect
Gain and loss don't fully offset.
Measure the residual
Change in basis = hedge result.
Worked examples
Example 1 — Basis narrows
+$0.10/bushelA farmer holds corn at spot $4.60 and sells futures at $4.80 (basis −$0.20). At harvest, spot is $4.10 and futures $4.20 (basis −$0.10).
| Loss on crop | −$0.50 |
| Gain on futures | +$0.60 |
| Net | +$0.10 (basis strengthened) |
The spread between cash and futures prices can widen or narrow, changing the hedge result.1
Example 2 — Basis widens
−$0.10/bushelSame start, but at harvest spot is $3.90 and futures $4.20 (basis −$0.30).
| Loss on crop | −$0.70 |
| Gain on futures | +$0.60 |
| Net | −$0.10 |
When the basis moves against the hedger, the hedge offsets only part of the loss.1
Example 3 — Cross hedge
Partial hedgeAn airline hedges jet fuel with crude oil futures; jet fuel jumps 15% while crude rises 10%.
| Unhedged gap | ≈ 5 points of the rise |
Hedging with a related but different asset adds basis risk, because the two prices don't move one-for-one. See Hedging.
Types of basis risk
| Aspect | Cause | Example |
|---|---|---|
| Location | Local vs delivery-point price | Farm vs exchange corn price |
| Quality / product | Different grade or asset | Jet fuel vs crude oil |
| Timing | Hedge expiry ≠ exposure date | Rolling contracts |
| Rate basis | Different interest benchmarks | SOFR vs other rates |
Who faces basis risk
Farmers and producers
Local vs futures prices.
Airlines and shippers
Fuel cross hedges.
Portfolio managers
Index futures vs a custom portfolio. See Beta.
Arbitrageurs
Trading the basis itself. See Futures Spreads.
Advantages and disadvantages
Advantages
- Basis is usually far less volatile than prices.
- Can be measured and tracked historically.
- Hedgers can sometimes profit from basis moves.
Disadvantages
- No hedge is perfect.
- Hard to forecast local or quality spreads.
- Cross hedges can fail badly in stress.
Going deeper
Read as far as you need. Each level builds on the one before it.
Hedge trades price risk for basis risk
Beginner
Hedgers accept basis risk in exchange for removing most of their outright price risk.1
Convergence at expiry
Intermediate
Futures and spot prices usually converge as delivery nears, so basis risk shrinks when hedge and exposure dates match. See Futures Convergence.
Hedge ratios
Advanced
Cross hedgers often size positions with a hedge ratio based on how the two prices have moved together historically, reducing but not removing basis risk.
Common mistakes
Assuming a perfect hedge
Some residual is normal.
Mismatched dates
Align expiry with exposure.
Ignoring local prices
Track your own basis history.
Wrong hedge size
Use a sensible hedge ratio.
Check your understanding
Test yourself before moving on. Each answer comes with an explanation.
Key points to remember
- Basis = spot price − futures price.
- Basis risk is the chance this gap changes.
- It makes hedges imperfect.
- Location, quality and timing all cause it.
- Hedgers swap price risk for smaller basis risk.
Frequently asked questions
Can basis risk be eliminated?
Is basis risk only for commodities?
What does a strengthening basis mean?
Further learning
Sources
This article is written in our own words. The sources below support the specific facts, rules and figures marked with a number in the text. Links open the original publisher’s page.
- Corporate Finance Institute. What is Basis Risk? (opens in a new tab) Checked .
- Corporate Finance Institute. Hedging (opens in a new tab) Checked .
Educational content, not financial advice. Examples use hypothetical prices and simplified costs; actual fees, margin rules and regulations vary by broker, market and country. We are not affiliated with any publisher linked above. Last reviewed . Report an error or request a source credit.