A hedge can reduce sensitivity to the underlying price while leaving an important question unresolved: which cash price is the contract actually offsetting? A basis measure is useful only after its sign, units and reference market have been specified.
Start with the definition
CME’s grain material defines basis as local cash minus futures. Its FX material uses futures minus spot, while its Treasury discussion adjusts futures prices by the bond conversion factor. Those conventions are appropriate to their respective contexts. Combining them in a single report without a definition can reverse the apparent meaning of a widening spread.
For this note, basis means futures minus cash, with both prices expressed in the same currency per unit. The measurement date is a hedge-review date before expiration, rather than a claim about delivery convergence.
Illustrative scenario: the residual matters
Assume an institution holds 100 units of an asset worth $100 per unit and shorts a futures exposure equivalent to 100 units at $102. The cash reference later falls to $90. Two hypothetical futures prices show why matching the direction alone does not determine the result.
| Review case | Futures price | Cash P&L | Futures P&L | Combined P&L |
|---|---|---|---|---|
| A · basis $1 | $91 | −$1,000 | +$1,100 | +$100 |
| B · basis $4 | $94 | −$1,000 | +$800 | −$200 |
The directional fall in the cash asset is identical. The difference comes from the relationship between the cash reference and the chosen contract. At the review point, the combined change is $300 less favorable in case B. This is a residual exposure to explain, rather than evidence that one hedge universally outperforms another.
Turn the observation into a review record
A useful analytical deliverable identifies the underlying reference, contract month, multiplier, position quantity and quote timestamp. It states the basis formula beside the number, preserves the original inputs and separates cash P&L, contract P&L and costs. Scenario changes should alter one declared assumption at a time before testing combinations.
This example assumes a one-for-one equivalent exposure, linear price changes and unchanged quantities. It excludes financing, transaction costs, margin cash timing and mismatches in quality, location or settlement. An actual comparison must examine those terms. The practical conclusion is to treat basis as a defined component of the mandate and data model, rather than an unexplained number at the end of a hedge report.