Quick Answer
The futures price applies at an approved delivery point and to a standard par grade. A commercial elsewhere pays freight to move the commodity to that point, and off-par grades deliver at a premium or discount. Both adjustments live in the local basis, so the same commodity carries a different basis in different places.
The futures price is one common number, but the commodity actually changing hands is not priced at flat futures. Two real-world adjustments (location and grade) move the local price, and the basis is what captures them.
Transportation Costs
A futures contract prices delivery at a specific approved delivery point. Anyone located somewhere else has to pay to bridge that distance.
- A commercial who is not at the delivery point must pay to move the commodity to (or from) that location, and that freight cost is built into the local basis.
- The farther a location sits from the delivery point, and the higher the freight, the weaker (more negative) the local basis tends to be. The local price has to absorb the cost of getting the commodity to where it can be delivered.
- Locations near the delivery point carry a stronger basis, since there is little freight to absorb.
- Transportation is one reason the same commodity has a different basis in different places on the same day: the futures price is common to everyone, but each location's freight-to-delivery cost is not.
Think of it this way: imagine the delivery point is the one grocery store that pays a fixed, posted price. If you live far away, you eat the gas money to get your goods there, so the price worth taking at your own door is lower. Distance drains the local basis.
Exam Tip: Gotchas
- Farther from the delivery point means a weaker (more negative) local basis, not a stronger one. The local price must absorb the freight to reach delivery, which drags it down relative to futures. Near the delivery point, the basis is stronger.
Deliverable Grades
A futures contract is written on one standard grade, and the exchange sets a schedule for delivering other grades above or below it.
- The contract is written on a standard par grade (also called the basis grade): the reference quality the futures price applies to.
- The exchange also lists other grades that are deliverable at a premium (better than par) or a discount (worse than par) to the contract price. The delivery provisions unit and the futures contract unit cover this grade schedule.
- A premium grade raises the effective price the deliverer receives; a discount grade lowers it. So the grade a commercial actually holds shifts its local cash price (and its basis) above or below the par-grade futures.
- The commodity actually changing hands is priced off the futures price adjusted for both its location (transportation) and its grade (premium or discount), which is precisely what the basis measures.
Exam Tip: Gotchas
- A premium grade raises the effective price; a discount grade lowers it. A better-than-par grade is worth more than flat futures, a worse-than-par grade less. Do not treat every deliverable lot as if it prices at the plain contract price.
- A commodity does not trade at one universal price. The futures price is common, but transportation to the delivery point and the deliverable grade adjust the effective local price, and those adjustments are exactly what the basis captures. Treating a far-from-delivery location or an off-par grade as if it prices at flat futures ignores the basis.