Does Basis Risk Exist in a Physically Settled Contract? Why or Why Not?
Yes, basis risk can still exist in a physically settled contract. While the price convergence is expected at expiration, the contract's price before expiration can still deviate from the spot price due to differing factors like delivery location, quality specifications, or the cost of carry.
The risk is minimized but not eliminated until the delivery process is complete.
Glossar
Delivery Process
Process ⎊ The delivery process in financial markets refers to the final stage of a transaction where the underlying asset or its cash equivalent is transferred from the seller to the buyer.
Physically Settled
Settlement ⎊ Physically settled derivatives contracts require the actual transfer of the underlying asset from the short position holder to the long position holder at maturity.
Spot Price
Valuation ⎊ The spot price in cryptocurrency, options, and derivatives represents the current market-clearing price for immediate delivery of the underlying asset, functioning as a fundamental benchmark for pricing more complex instruments.
Basis Risk
Exposure ⎊ The core of basis risk within cryptocurrency derivatives, particularly options, stems from the imperfect correlation between the price movements of the underlying asset and its derivative contract.