Returning to Futures contracts, basic risk refers to the risk remaining after the hedge has been put in place and essentially represents the difference between the Futures price – should the Futures position be closed prematurely – and the spot price. It also includes other components such as:

. The price of cleaning the local grade of the commodity into a grade deliverable in a Futures contract (or the premium for a superior grade).
. The price of transportation to or from the delivery point in the Futures contract.
. The physical cost of storage, including insurance, between the time of the harvest and the delivery date of the Futures contract.

-- Page 7, Commodities and Commodity Derivatives: Modeling and Pricing for Agriculturals, Metals and Energy

While in the same book:

1. Understanding basis risk is fundamental to hedging. Basis is defined as:
Basist,T = Spot pricet - FT(t)
is usually quoted as a premium or discount: the cash price as a premium or discount to the Future price.
The basis is said to be one dollar "over" Futures if the spot price is one dollar higher than the Futures price.

2. There are several types of basis risk:

(a) In the case of a trading desk which needs to cut at date t (e.g., to avoid negative margin calls) – a position in Futures which was meant to hedge a position in the spot commodity – the basis risk is represented by the quantity defined above.
(b) More generally, basis risk exists when Futures and spot prices do not change by the same amount over time and, possibly, will not converge at maturity T

-- Page 14, Commodities and Commodity Derivatives: Modeling and Pricing for Agriculturals, Metals and Energy

I feel confused about the terminology used here. I have never run across basic risk before. And I don't think it's a typo because the index of the book indeed also explicitly references basic risk.

Are basic risk and basis risk the same?

  • $\begingroup$ I've never heard anyone talking of basic risk. Basis risk is the broader risk term when position is hedged using an instrument that has certain correlation with the underlying (e.g. futures here). You can see if "basic" risk is referred elsewhere in the book in index. My guess is it will not be. In any case "basis" risk is important from hedging point of view as it can lead to pretty bad results if risk management is not paying attention to the hedge. $\endgroup$ – Taran Jul 28 '14 at 22:21
  • 2
    $\begingroup$ Its a typo. The basic risk as described is in fact basis risk. $\endgroup$ – JayInNyc Aug 1 '14 at 15:28

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