Cost of Carry and Basis in Futures Explained
Written by Ipsita Baishya
Reviewed by Gaurav Garg, SEBI-registered Research AnalystBasis is the gap between a futures price and the spot price of the same asset. The formula is simple: basis = futures price minus spot price. Cost of carry explains why that gap exists at all: it is mostly the interest you give up by locking up money in the asset today, minus any dividends you would have collected.
On the NSE, index and stock futures usually trade slightly above their spot prices. That premium is not a forecast of a market rise. It is the price of time.
What Basis Actually Measures
Take the Nifty 50 spot at 24,000 and the current month future at 24,138. Basis is +138 points. Traders often quote it as a percentage of spot, so 138 divided by 24,000 gives roughly 0.58% for that expiry.
Basis is not fixed. It moves through the day as pressure hits the futures leg harder than the cash leg, or vice versa. Arbitrage desks watch it, because a wide enough gap lets them buy cash and sell futures for a near-riskless return.
The Cost of Carry Formula
The theoretical fair value of a future is:
- Futures price = Spot x (1 + r x t / 365) minus expected dividends
- r is the financing rate for the period, roughly the T-bill or money market rate
- t is the days remaining to expiry
Worked example: all figures are illustrative. Nifty spot is 24,000, with 30 days to expiry and a financing rate of 7% per year. Carry works out to 24,000 × 0.07 × 30/365, which is about 138 points. Fair futures value is 24,138.
Now add dividends. If index constituents are expected to go ex-dividend for a combined 30 index points before expiry, fair value drops to about 24,108. Dividends reduce carry because the shareholder receives them, whereas the futures buyer does not.
A Single Stock Example
A stock trades at Rs 1,450 with 45 days to expiry and a 7.5% financing rate. Carry is 1,450 x 0.075 x 45 / 365, about Rs 13.4, so fair futures value is close to Rs 1,463. If the company has announced a Rs 20 dividend with an ex-date before expiry, the fair value slides to roughly Rs 1,443, which is below the spot price.
Contango and Backwardation
Two words describe the shape of the basis, and they get mixed up constantly.
| Feature | Contango | Backwardation |
|---|---|---|
| Futures vs spot | Futures above spot | Futures below spot |
| Basis sign | Positive | Negative |
| Usual cause | Normal financing cost | Dividends, heavy short interest, borrowing stress |
| How common in India | The default state for index futures | Occasional, often event-driven |
| Far month vs near month | Far month richer | Far month cheaper |
Why Basis Converges to Zero at Expiry
Every futures contract has a settlement rule that forces convergence. Nifty and Bank Nifty settle at the underlying index value on expiry day, taken as a weighted average of constituent prices in the last half hour. Once t reaches zero, carry is zero, so nothing justifies a gap.
Watch the last two sessions of any series, and the basis grinds towards nothing. If it did not, an arbitrageur could sell the richer leg, buy the cheaper one, and pocket the difference at settlement. While that gap remains open, it is called basis risk because a futures hedge never perfectly tracks a cash position until the final print.
What a Negative Basis Is Telling You
A futures price below spot is worth investigating, not trading on reflex. Common reasons:
- An expected dividend. The single most boring and most frequent explanation. Check the corporate action calendar first.
- Shorting pressure. Since retail short selling in the cash market is intraday only, traders often express bearish views through futures, which pushes that leg down.
- Hedging by holders. Institutions holding a stock may sell futures against it, which is supply on the futures side only.
- Position limit or ban period stress. When a stock crosses 95% of market-wide position limits, only offsetting trades are allowed, and prices can dislocate.
The common misconception is that a negative basis means the market has turned bearish. Sometimes it does reflect bearish positioning. Often it is only arithmetic from a dividend everyone already knows about.
Frequently Asked Questions
Is cost of carry the same as the interest rate?
The financing rate is the main input, but carry is the net figure after subtracting expected dividends. For commodities, you would also add storage and insurance costs, which is where the phrase originally came from.
Can I earn the basis as a retail trader?
Cash and carry arbitrage is possible but thin after costs. STT, brokerage, exchange fees, and the margin blocked on the futures leg eat most of a 0.5% monthly gap, and you must hold to expiry to capture it cleanly.
Does basis affect option prices too?
Yes, indirectly. Indian index options are priced off the futures level more than off the spot level, especially for monthly expiries. Hence, a rich basis lifts call premiums and trims put premiums relative to spot-based intuition.
Why do far-month futures show a wider basis?
More days remaining means more carry. A three-month contract carries roughly three times the financing cost of a one-month contract, assuming the same rate and no dividends in between.
Key Takeaways
- Basis equals futures price minus spot price, and it reflects carry rather than a market forecast.
- Fair value is spot x (1 + r x t / 365) minus expected dividends over the period.
- Contango means positive basis; backwardation means negative basis.
- Basis must converge to zero at expiry because the final settlement is tied to the underlying.
- Check the dividend calendar before reading a negative basis as bearish sentiment.
