Why Is Basis Risk Typically Lower for Physically Settled Crypto Derivatives?
Physically settled derivatives require the actual delivery of the underlying asset upon expiration. This mechanism forces the derivative price to converge precisely with the spot price near expiration, as any deviation would create an immediate, risk-free arbitrage opportunity.
Cash-settled derivatives, which settle based on an index price, can sometimes diverge from the spot price, increasing basis risk.
Glossar
Physically Settled Crypto
Settlement ⎊ Physically settled crypto derivatives represent a class of contracts where the obligation at expiry is fulfilled through the direct delivery of the underlying cryptocurrency asset, rather than a cash settlement.
Risk-Free Arbitrage
Arbitrage ⎊ The theoretical possibility of generating risk-free profit by exploiting price discrepancies for identical or equivalent assets across different markets or exchanges represents a cornerstone of financial theory.