What Is Basis Risk When Using Crypto Futures for Hedging?
Basis risk is the risk that the price of the asset being hedged (the spot price) and the price of the futures contract do not move perfectly in tandem. The "basis" is the difference between the spot price and the futures price.
If the basis changes unexpectedly between the time the hedge is initiated and the time the position is closed, the hedge will not be perfectly effective, leading to a loss or gain on the combined position.
Glossar
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.
Short Hedge
Mitigation ⎊ A short hedge, within cryptocurrency derivatives, represents the strategic establishment of a short position in a related asset to offset potential losses stemming from an existing, long exposure.
Futures Contract
Leverage ⎊ Futures contracts in cryptocurrency represent agreements to buy or sell an underlying asset at a predetermined price on a future date, functioning as a derivative instrument that allows for amplified exposure without immediate asset ownership.
Crypto Futures
Product ⎊ Crypto futures are standardized, exchange-traded contracts obligating the holder to buy or sell a specific quantity of a cryptocurrency at a predetermined price on a specified future 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.
Long Hedge
Hedge ⎊ A long hedge, within the context of cryptocurrency derivatives, represents a strategy designed to mitigate downside risk associated with an anticipated price decline in an underlying digital asset.