Basis trading is a financial arbitrage trading strategy that involves the trading of a financial instrument, such as a financial derivative or a commodity, with the motive of profiting from the apparent mispricing of the securities.
It is also referred to as cash-and-carry trade.
The term basis trading refers to an arbitrage strategy used by investors to profit from the mispricing of two related securities.
The arbitrager believes that as the mispricing of the securities experiences a correction over time, there will be again on one side of the trade that will more than offset the loss on the other side of the trade.
Trade Basis = Cash Price of a Security - Futures Price of a Security
For example, consider a cash 5-year note, the 1.75% of November 30, 2021, versus the March 2017 5-year U.S. Treasury futures contract (FVH7).
Assume the price of the cash security to be 99-10+ (1/32), the price of FVH7 to be 117-18+ (1/32), and the conversion factor (CF) of the cash security versus March 2017 5-year futures to be 0.8292. Because of the U.S.
Treasury cash and futures products trade in full points and fractions of a 1/32 we must first convert our futures and cash prices to decimal then perform the math, then convert back to 1/32 form.