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Basis trades, explained but not recommended

Lesson 16 · about 9 min

You will hear the words "cash and carry", "basis trade" and "delta neutral yield" from people who describe them as risk-free income. This lesson explains what the trade is, where the return actually comes from, and the ways it loses money, so that you can recognise it when it is being sold to you. It is not a recommendation to run one.

The basis

The basis is the difference between a derivative's price and the spot price. When a perp trades above spot, the basis is positive and (as Module 4, Lesson 1 showed) longs pay funding to shorts. When a dated future trades above spot, the basis is the premium that will shrink to zero at expiry, because the future must settle at spot.

A basis trade captures that gap while being hedged against the price of the coin.

The perp version

  1. Buy 1 BTC on spot.
  2. Short 1 BTC on the perp.
  3. Hold.

Your exposure to BTC's price is zero: if BTC rises $1,000, the spot leg gains $1,000 and the short perp loses $1,000. What you collect is funding. When the rate is +0.01% per 8 hours, you receive 0.01% of notional three times a day, about 11% annualised. When funding spikes to +0.10% during a rally, the same trade yields over 100% annualised for as long as it lasts.

The dated-future version

  1. Buy 1 BTC on spot at $60,000.
  2. Sell a three-month future at $61,500.
  3. Hold to expiry, when the future settles at spot.

Whatever BTC does, you have locked in $1,500 on $60,000 over three months: 2.5%, or about 10% annualised. No funding to track; the return is fixed at entry.

Key idea: A basis trade is long spot, short derivative, collecting the premium between them. Its return is the funding rate or the futures premium; its risks are everything that can break the hedge, and there are more of those than the pitch admits.

Where the money actually comes from

Funding is paid by leveraged longs. The basis trade's yield is therefore a loan to speculators, collected in instalments, and it is high precisely when speculation is most frantic. That tells you two things. The yield is not "free"; it is compensation for being on the other side of a crowded, leveraged position, on an exchange, during a mania. And it disappears, or reverses, exactly when the mania ends.

How it loses

Funding flips. In a sell-off, the perp trades below spot and funding turns negative. Now you, the short, are paying. A trade that yielded 30% annualised can cost 30% annualised within days. If you exit, you pay fees and slippage on both legs, often into the same chaotic market.

The short leg gets liquidated. Your short perp needs margin. If BTC rallies 40%, the spot leg is up 40%, but that gain is sitting in a wallet or a spot account, not in the perp margin account. The perp short is losing 40% of notional and, unless you posted enough margin or the exchange lets spot collateral back the perp (some do, with a haircut), it gets liquidated. You are left long spot with no hedge at the top of a rally, having paid a liquidation fee. Running the trade safely means low leverage on the short (2x or less) and a system for topping up margin, which cuts the return substantially.

Exchange risk on both legs. Both the spot coins and the perp margin sit on an exchange. Module 2's lesson on FTX is the whole risk statement. Many traders who considered themselves hedged in 2022 had their entire "risk-free" position inside the bankruptcy estate.

Stablecoin risk. The trade is usually margined and settled in a stablecoin. A de-peg breaks the arithmetic.

Execution risk. The two legs are not placed at the same instant. If the price moves between them, you enter with an unintended directional position. On thin alts, the slippage on one leg can exceed a month of the expected basis.

Fees. Two entries and two exits at taker rates on a $60,000 notional is roughly $120 to $240 depending on the venue, or up to a month of yield at neutral funding.

Opportunity and complexity. You are managing margin on one exchange, custody on another (if you were sensible), funding every 8 hours, and a decision rule for when to close. This is a job, and it pays less than it looks.

Why it is taught here

Three reasons. First, so you can recognise "delta neutral yield" products, which are this trade with an extra layer of counterparty risk and a fee, when they are offered to you. Second, because understanding who pays funding and why makes you a better reader of perp markets even if you never run the trade. Third, because "risk-free" is a phrase that should trigger the same reflex in you as "guaranteed": look for the risk the speaker is not mentioning.

If, after all that, you want to experiment, do it with an amount you could lose entirely, at 1x on the short leg, on one reputable exchange, with the exit rule (close both legs when funding goes negative for N consecutive intervals) written down before you enter.

Try it: Take a three-month future at a 2% premium to spot. Compute the annualised return. Then subtract a realistic round trip of fees (0.05% taker on four executions of the full notional) and a 1% margin buffer that you must leave idle, and recompute. Note how much of the headline yield survives.

Recap

  • A basis trade is long spot plus short perp (collecting funding) or short dated future (collecting the premium to expiry).
  • The yield is paid by leveraged longs and is highest during manias, which is also when it reverses fastest.
  • Losses come from funding flipping negative, liquidation of the short leg, exchange failure on both legs, stablecoin de-pegs, execution gaps and fees.
  • "Delta neutral yield" products are this trade with extra counterparty risk added.
  • Understand it so you can read funding and decline the pitch; do not treat it as income.

See it drawn

Original diagrams for the ideas on this page. Illustrative, not real market data.

Margin and leverageA small deposit controlling a much larger position, and the point at which losses trigger a margin call.Position you controlnotional value $100,000your margin deposit: $5,000$100,000 / $5,000 = 20:1 leverageYour deposit absorbs every dollar of loss$5,000$2,500$0Equity leftMARGIN CALLequity has fallen to $2,5000%1%2%2.5%3%4%5%How far the price moves against you
Margin and leverage. A $5,000 deposit can control a $100,000 position, which is 20:1 leverage. Because the loss is measured on the full $100,000, a 2.5% move against you halves the deposit and brings a margin call, and a 5% move uses all of it.
Slippage on a market orderA buy order clears four price levels, so the average price paid is worse than the price first quoted.Buy 1,000 shares at marketpricesell orders resting (bar length = size)20.04300 shares20.03200 shares20.01200 shares20.00300 sharesnothing resting at 20.02order sweeps up the bookaverage fill 20.02SLIPPAGE0.02 a share$20.00 in totalintended 20.00Each level fills at its own price; the average is what you really paid.
Slippage on a market order. You click at 20.00, but only 300 shares are resting there, so the rest of the order fills at 20.01, 20.03 and 20.04. The average price paid is 20.02, and that two-cent gap is slippage.
How a call option's delta changes with the underlying priceAn S-shaped curve rising from zero, passing through about a half at the strike, and flattening near one.Delta of a call option1.000.5008090110120Out of the moneyAt the moneyIn the money1.00 means it moves one-for-one with the stockdelta ≈ 0.50 at the strikeStrike 100Underlying price
Delta across the range of prices. Delta says how much a call's price moves for a one-point move in the stock. Far below the strike it is near 0 and the option barely reacts; at the strike it is about 0.50; far above it approaches 1 and tracks the stock.

Finished this module? Take the module quiz.