In terms of how basis is “quoted” I guess you could say…is it objective(in that it does not matter which side of the trade you are on the basis is the basis). So for example on slide 41 (of Financial Markets and Products video) on May of 08 the basis is .20…does this mean the basis is .2 regardless of whether you are buying spot selling future or selling spot buying future? Or is basis quoted subjectively (dependent on ones position)? So if I sell the spot of 4 and buy the future of 3.8 at this moment my basis is .2 and someone buying spot of 4 and selling future of 3.8 is -.2?
Basis Question
- Thread starter Turner737
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Hi Matt,
It's a good point, and the framing is not helped by the fact that, according to Hull, while basis(0) = Spot - F(0), it can in the case of investment commodities be reversed with basis (0) = F(0) - S(0). However, this is a nice use case of a general principle: we try to avoid entirely subjective frames. I see attempts to frame subjective constantly, and the problem is they invariably lead to confusion because, well, they are subjective and then each price/value/basis requires a qualifier "from the long/short's perspective." This happens especially with credit derivatives, like a CDS, where subjectively one counterparty's gain is another's loss. But still, in most cases that i can think of, PRICE (value, replacement cost ... ) works as an entirely objective frame.
It's a slightly different issue than consistency. Of course, the first thing is to define the basis consistently, and we should probably follow Hull with B(0) = S(0) - F(0). So, if the spot (may 2008) = $4.00 and the forward F(0, may 2008) = $3.80, then the basis is $4 - 3.8 = +$0.20 to both parties, the long and the short.
BTW, it's beyond your question, but good notation is part of the "solution" to a potential interpretation problem. If I look at gold's forward (futures) curve right now, http://www.cmegroup.com/trading/metals/precious/gold.html , notice the Aug 2012 futures price is 1647.5 and the Dec 2012 futures price is 1652 (of course, these may change by the time you look at them!). So, if the spot price of gold is today $1,640, we can write that gold's basis curve today includes basis(0,4) = S(0) - F(0, 4) = $1,640 - 1,647 = -$7 and basis (0, 8) = S(0) - F(0,8) = 1,640 - 1,652 = -$12. As of today (T0), this is a entire curve of bases, a different basis for each forward maturity.
... and, btw #2, under this definition of basis, a positive basis implies backwardation [inverted forward curve]. We could safely define backwardation (contango) as a situation in which a basis increases (decreases) with forward contract maturity; i.e., F(X) < S(0) = backwardation = positive basis.
I hope that helps.
It's a good point, and the framing is not helped by the fact that, according to Hull, while basis(0) = Spot - F(0), it can in the case of investment commodities be reversed with basis (0) = F(0) - S(0). However, this is a nice use case of a general principle: we try to avoid entirely subjective frames. I see attempts to frame subjective constantly, and the problem is they invariably lead to confusion because, well, they are subjective and then each price/value/basis requires a qualifier "from the long/short's perspective." This happens especially with credit derivatives, like a CDS, where subjectively one counterparty's gain is another's loss. But still, in most cases that i can think of, PRICE (value, replacement cost ... ) works as an entirely objective frame.
It's a slightly different issue than consistency. Of course, the first thing is to define the basis consistently, and we should probably follow Hull with B(0) = S(0) - F(0). So, if the spot (may 2008) = $4.00 and the forward F(0, may 2008) = $3.80, then the basis is $4 - 3.8 = +$0.20 to both parties, the long and the short.
BTW, it's beyond your question, but good notation is part of the "solution" to a potential interpretation problem. If I look at gold's forward (futures) curve right now, http://www.cmegroup.com/trading/metals/precious/gold.html , notice the Aug 2012 futures price is 1647.5 and the Dec 2012 futures price is 1652 (of course, these may change by the time you look at them!). So, if the spot price of gold is today $1,640, we can write that gold's basis curve today includes basis(0,4) = S(0) - F(0, 4) = $1,640 - 1,647 = -$7 and basis (0, 8) = S(0) - F(0,8) = 1,640 - 1,652 = -$12. As of today (T0), this is a entire curve of bases, a different basis for each forward maturity.
... and, btw #2, under this definition of basis, a positive basis implies backwardation [inverted forward curve]. We could safely define backwardation (contango) as a situation in which a basis increases (decreases) with forward contract maturity; i.e., F(X) < S(0) = backwardation = positive basis.
I hope that helps.
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