What Is “Basis Risk” in Derivatives Trading?

Basis risk is the risk that the price of the underlying asset being hedged does not move in perfect correlation with the price of the derivative used to hedge it. The "basis" is the difference between the spot price of the asset and the futures price.

Basis risk arises when the basis changes unexpectedly between the time the hedge is initiated and when it is closed out. This imperfect correlation can lead to unexpected losses in the hedged position.