Now that we understand what the term ‘basis’ means, we can turn our attention to understanding changes in a basis. A basis can either 'strengthen' or 'weaken'.
A strengthening basis means that the basis has moved upwards. It has become more positive or less negative. Another term for this is 'increasing basis'. A strengthening basis can occur in the following ways:
A weakening basis means that the basis has moved downwards. It has become less positive or more negative. This is also known as a decreasing basis. It can occur in the following ways:
Reasons for a change in the basis
Strengthening and weakening bases are short-term phenomena that mostly result from short-term changes in the demand and supply of a commodity. If there is a strong short-term demand for a commodity but the commodity is in short supply, its spot price may increase relative to its futures price. This would result in a strengthening basis.
Conversely, if a commodity is available in abundance but is not in high demand, its spot price may fall relative to its futures price. This would reduce the difference between the two prices and lead to a weakening basis.
Strengthening and weakening bases are big risks for commodities traders because they affect the payoff. The risk of a decrease in a payoff because of a change in the basis is called a basis risk .