Definition
Basis risk is the risk that the price relationship between an underlying asset and the instrument used to hedge it, such as a futures or perpetual contract, changes unfavorably over time. It reflects the possibility that the basis—the difference between the derivative price and the spot price—does not behave as expected, leaving a position partially unhedged. Even when a hedge is constructed to be theoretically neutral, fluctuations in this basis can generate unexpected gains or losses.
In trading contexts, basis risk is a form of mismatch risk that persists even when nominal exposures appear offset. It is distinct from price level risk on the underlying itself, because it arises from imperfect correlation between the hedge and the asset rather than from outright market direction. This risk is especially relevant for strategies that rely on a stable or converging basis, such as a basis trade implemented as part of broader hedging activity.
Context and Usage
Basis risk is a central consideration whenever traders or institutions use derivatives to hedge spot positions instead of transacting directly in the same instrument. Changes in liquidity, funding rates, market structure, or idiosyncratic flows can all cause the basis to widen or compress, altering the effectiveness of a hedge. As a result, a position that appears fully hedged on notional terms can still experience profit and loss driven purely by movements in the basis.
In more complex strategies, basis risk interacts with other trading frictions such as slippage, which reflects execution price deviations rather than ongoing price relationship changes. Market participants monitoring a basis trade or other hedging structures track basis risk as a distinct component of their overall risk profile, recognizing that it cannot be fully eliminated when the hedge instrument and the underlying asset are not perfectly identical.