Definition of a Basis Trade
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basis trade is an investment strategy that involves simultaneously taking opposite positions in an asset's spot market and its corresponding futures market
1. This strategy is designed to be
delta-neutral, meaning it is not exposed to the directional price movement of the underlying asset
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The core objective of a basis trade is to profit from the "basis," which is the price differential between the spot price of an asset and the price of its futures contract
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Mechanics of the Basis Trade
The trade is executed by:
- Purchasing (or selling) the underlying asset in the spot market 1.
- Simultaneously selling (or buying) the futures contract for that same asset 1.
Since the spot and futures prices are traded separately, they often diverge
1. As the futures contract approaches its expiration date, its price is expected to converge toward the underlying spot price, with the basis ideally approaching zero at expiration
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Example of a Positive Basis Trade
If a futures contract is trading at a premium to the underlying spot price (a positive basis), a trader can execute the following steps to collect the difference
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- Buy the asset in the spot market.
- Short the futures contract 1.
As the futures contract converges to the spot price at expiration, the trader collects the difference in the basis
1. Fixed expiry futures provide a fixed interest rate on this type of basis trade
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For instance, if the ETH/USD spot price is $1,719.80 and the December 30 expiry futures price is $1,723.50, the basis is $3.70 ($1,723.50 - $1,719.80)
1. This difference can be annualized to calculate a potential return
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Basis Trading in Crypto Markets
The basis trade is considered a liquid and popular strategy in crypto due to its simplicity, lack of directional exposure, and relatively predictable yield
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- Delta-Neutral Arbitrage: At its core, the basis trade is a delta-neutral arbitrage strategy that exploits the differential between spot and perpetual futures (perps) prices 2.
- Funding Payments: In the context of perpetual futures, the trade often involves shorting the perp contract and collecting funding payments from long perp holders 2.
- Yield Generation: The yield of the basis trade is fundamental to crypto money markets 4. For example, basis trading on platforms like Lyra has yielded approximately 10–70% APY before factoring in rewards 2.
- Institutional Adoption: The availability of spot Bitcoin exchange-traded funds (ETFs) has made executing the basis trade easier for institutional investors 5. Hedge funds have used this strategy to take record net short positions on Bitcoin futures while simultaneously buying spot ETFs 5. Similarly, hedge funds have built large short positions on ETH CME futures while buying spot ETH ETFs to capture an annualized yield 3.
While the basis trade is delta-neutral, it is important to note that it is
not risk-free 4. Traders must consider that funding rates are not constant and can flip negative, which would make the strategy less profitable or unviable
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