How Can Basis Risk Be Minimized or Managed?
Basis risk can be minimized by selecting a hedging instrument that closely matches the underlying asset being hedged. This means choosing a futures or forward contract with the same underlying commodity, delivery location, and expiration date, if possible.
When a perfect match is not available, a trader can analyze historical price relationships between the asset and various hedging instruments to find the one with the highest correlation. Regularly monitoring and adjusting the hedge as market conditions change can also help manage basis risk effectively.
Glossar
Market Conditions
Dynamic ⎊ Market conditions describe the prevailing state of the financial environment, encompassing factors like price volatility, trading volume, liquidity depth, and general investor sentiment across cryptocurrency and derivatives markets.
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.
Correlation
Interdependence ⎊ The concept of correlation, within cryptocurrency derivatives and options trading, fundamentally describes the statistical relationship between two or more assets, indices, or variables.
Hedging Instruments
Mitigation ⎊ Hedging instruments, within cryptocurrency and derivatives markets, function as strategic offsets to potential adverse price movements, extending beyond simple directional protection.
Price Relationships
Correlation ⎊ The statistical measure describing how the price movements of a cryptocurrency futures contract align with its underlying spot asset or related derivatives.
Financial Derivatives
Stewardship ⎊ Involves engineering these contracts to explicitly manage or incentivize positive externalities, such as climate risk exposure or carbon credit valuation.