Booking the Basis

Booking the basis is an arrangement made with regard to a forward sales arrangement between a buyer and seller. Rather than specifying the cash price on the sales up front, this arrangement gives either party the ability, at some future date, to determine the cash price of the forward sales agreement. Once the basis of a contract is known, it is applied to the price fixed at the beginning of the arrangement, and then maintained for the duration of the contract. This practice is also known as "deferred pricing."

Booking the basis essentially locks in the current basis, or the discrepancy between the futures contract price and the spot price of the underlying asset. This may be put into use by traders or firms who believe that the basis will expand or contract in the future and wish to hedge themselves against that risk.

"Booking the basis" is used to calculate what the price of a sales agreement will be at some time in the future. First the two parties to a transaction agree upon the formula or basis for the deal. Then, at a later date, the final price is found by applying the previously agreed upon basis to the current price levels. The agreed upon basis may be either positive or negative, and is typically understood as the difference between the spot price and the futures price in the market.

For instance, imagine that a forward sales agreement for delivering cotton is inked in June, with the buyer and seller agreeing to a time horizon ending in November. Both parties also agree that a basis of $25 will be added to the current price quote. They may agree to this level because the spot price for cotton is trading at $200 while the front month futures contract is trading for $225.

Since the basis has booked, this means that the buyer, the seller, or both parties will have the option to declare at an earlier date that that of the time horizon, say in August when there is a futures price of $210, that payment should now be made. The total payment would be $235 ($210 + $25), adding the original basis to the current price - even if the current basis implied by the spot and futures markets is different from $25. By booking the basis, both sides have locked in a $25 basis.