How Does “Basis Risk” Relate to Cash-Settled Derivatives?
Basis risk is the risk that the price of the derivative contract does not perfectly track the price of the underlying asset or index, which is the "basis." In cash-settled derivatives, if the settlement price (the index) deviates significantly from the trader's exit price, the hedging effectiveness is reduced. This risk is inherent because the derivative is priced off a benchmark, not the specific spot price a trader might transact at.
Glossar
Perpetual Swaps
Derivatives ⎊ Perpetual swaps represent a class of financial derivatives, specifically within the cryptocurrency ecosystem, that replicate the payoff of a futures contract without a fixed expiration date.
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.
Hedging Effectiveness
Mitigation ⎊ Within cryptocurrency derivatives and options trading, hedging effectiveness fundamentally assesses the degree to which a hedging strategy reduces exposure to adverse price movements, particularly relevant given the inherent volatility of digital assets.