1.4.2.5. Short and Long Basis Position
Remember that an investor who is long a commodity owns the commodity, expecting its price to go up. If he fears its price will go down, the investor will either sell the commodity or hedge his position by shorting a futures contract. If he shorts a futures contract, the hedger is said to have taken a position in the basis. He is both long the asset and short the futures contract. By shorting the futures contract and keeping the commodity, the hedger has bought the current basis.
Short hedgers are said to have a long basis position or to be long the basis, because they have bought the basis and expect its value to strengthen, or go up. They expect the basis to become less negative or more positive. A strengthening basis will increase a short hedger’s profit when he offsets his futures position.
Example: When Ralph sold his September corn futures contract in the previous example, the cash price was $2.52 and the September futures price was $2.74. In shorting the contract, he took a long position on the -$0.22 basis. He did this because he thought the basis would strengthen and he could get more than the $2.52 being offered by his local grain elevator.
At harvest time in late August, he cashed out the contract when the cash price had fallen to $2.40 and September futures were selling at $2.60. Although the cash price for corn had dropped by 12 cents, the basis for the September contract had strengthened to -$0.20. Ralph offset his futures contract and sold his corn in the cash market.
If the basis had remained unchanged, Ralph would have earned $2.52 per bushel ($2.74 minus $0.22). Because the basis had strengthened, he earned $2.54 per bushel ($2.74 minus $0.20). By taking a long basis position, Ralph earned a two-cent profit.
Conversely, a long hedger takes a short basis position, meaning that the buyer of a futures contract in effect sells the current basis. A cereal manufacturer, for example, fearing a rise