Weakening basis
Also written Weakening of basis · Basis weakening
A change in basis (spot minus futures) towards a less positive or more negative number — futures rising relative to spot — which benefits a long hedger.
In plain language
With basis defined as spot minus futures, the basis weakens when it becomes less positive or more negative.
From +20 to +15 is weakening, even though it is still positive. From -200 to -250 is weakening too.
In price terms, weakening comes from spot falling and/or futures rising relative to each other — a move in the direction of contango. In a backwardated market the basis weakens to zero as the contract converges at expiry.
The party it helps is the long hedger: short or yet to buy in the physical market, long in futures.
How it works
Who is the long hedger? Chapter 5 defines a long hedge as long futures and selling in spot. It is typically a processor worried that raw material prices will rise. Long hedgers benefit when the basis weakens — futures going up, spot coming down.
The market table:
| Market | Basis change | Benefits |
|---|---|---|
| Contango | Weakening | Long hedger |
| Backwardation | Weakening | Long hedger |
| Either | Strengthening | Short hedger |
The long hedger's result equals the negative of the change in basis. Short spot and long futures: (Futures change) - (Spot change). When basis falls by 200, he gains 200.
Why backwardation is common in agri markets (Chapter 5): longer staggered delivery periods, and seasonal arrivals of crops — arrival months in rabi and kharif crops generally show significant backwardation, changing with crop and monsoon forecasts. As that backwardation unwinds, the basis weakens.
A worked example
The workbook's simple case.
| Day | Spot | Futures | Basis |
|---|---|---|---|
| 1 March | 1,100 | 1,300 | -200 |
| 15 March | 1,200 | 1,450 | -250 |
The basis went from -200 to -250: weakened by 50. A long hedger (short spot, long futures) loses 100 on spot and gains 150 on futures — net +50. A short hedger holding the opposite positions would have lost 50.
The workbook's long-hedger table (backwardation).
| Date | Spot | Futures | Basis |
|---|---|---|---|
| 1 June | Sell at 1,800 | Buy at 1,500 | +300 |
| 15 June | Buy at 1,400 | Sell at 1,300 | +100 |
| Result | +400 | -200 | |
| Net | +200 |
The basis weakened from +300 to +100, and the long hedger made 200.
In rupees, on 50 quintals (illustrative):
Spot gain = +400 x 50 = Rs 20,000
Futures loss = -200 x 50 = Rs -10,000
Net = Rs 10,000
Both prices fell here, and the long hedger still came out ahead — because spot fell further than futures.
Why NISM asks about it
Chapter 5, section 5.6 (Basis), defines weakening with the +20 to +15 illustration, the 1 March / 15 March table and the backwardation long-hedger table, and explains why backwardation is common in agricultural markets. Section 5.2 covers long and short hedges. Expect "which hedger benefits from a weakening basis?" and questions pairing contango/backwardation with strengthening/weakening.
Common exam traps
- A positive basis can weaken. +20 to +15 is weakening.
- Weakening benefits the long hedger, in both contango and backwardation.
- The workbook's definition of a long hedge is long futures and selling in spot. Do not import a different definition of which leg is which.
- Weakening does not require futures to rise. In the backwardation table futures fell 200 and the long hedger still gained.
- Convergence weakens a backwardated basis to zero by expiry.
- The market type and the basis change are independent. Each of contango and backwardation can see either strengthening or weakening.
- Strengthening and weakening describe the change, not the level. A -250 basis is not "weak"; it is weaker than -200.
Check yourself
1.A processor hedges his raw material purchases by going long futures. Which basis movement benefits him?
- a)Strengthening basis, in a contango market only
- b)Weakening basis, in both contango and backwardation markets
- c)Strengthening basis, in both contango and backwardation markets
- d)Weakening basis, in a backwardation market only
Show the answer
Answer: (b) Weakening basis, in both contango and backwardation markets
"LONG HEDGE is associated with LONG IN FUTURES and selling in spot. Thus, LONG HEDGERS BENEFIT IF THE BASIS WEAKENS, i.e. FUTURE PRICE GOING UP AND SPOT PRICE COMING DOWN. Generally, long hedge happens FOR RAW MATERIALS BY PROCESSORS, wherein the processors expect their raw material prices may increase."
And the market-type table confirms it holds in both conditions:
Market Type Basis Preferred position Contango Strengthening Short hedger Contango Weakening ⚠️ LONG hedger Backwardation Strengthening Short hedger Backwardation Weakening ⚠️ LONG hedger Options (a) and (d) are built on the assumption that the market condition matters. It does not. Contango and backwardation describe where the basis IS; strengthening and weakening describe where it is GOING — and only the second determines who gains.
The intuition: a long hedger is long futures and will sell in spot. He therefore wants futures to rise relative to spot — which is precisely weakening basis, since basis = spot − futures.
The mirror case: "SHORT HEDGE happens with FINISHED GOODS by processors/manufacturers. SHORT HEDGERS BENEFIT WITH STRENGTHENING OF BASIS, i.e. spot price going up and futures price falling."
Where this is taught
Free preparation for NISM Series XVIRelated terms
- Basis riskThe risk left over after hedging, because the exposure and the contract used to hedge it do not move identically — in size, in expiry date, or in what they are written on.
- ConvergenceThe certainty that a futures price and the spot price of its underlying meet at expiry — because on the last trading day the contract settles at the cash market price, leaving no room for a difference.
- BasisThe difference between the spot price and the futures price of an asset — positive when spot exceeds futures, negative when futures exceeds spot, and zero at expiry.
- Long hedgeA hedge made by buying futures to protect against a price rise before a planned future purchase — the gain on futures offsets the higher cash price, locking in roughly the futures price.
- BackwardationA market in which the futures price sits below the spot price — the cost of carry says futures should be dearer, and something is overriding it.
- Strengthening basisA change in basis (spot minus futures) towards a more positive or less negative number — spot rising relative to futures — which benefits a short hedger.