# Basis Basics - Pt 2

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Published On

August 18, 2022

Here we pick up where Basis Basics - Part 1 left off by discussing advanced basis trading strategies. We introduce the concept of leveraged basis trading, and we provide a framework for deciding between lending and basis trading on both fixed-expiry and perpetual futures.

### Basis Background

In part 1 of the series, we defined a spot-futures basis $$b$$ as the difference between a futures price $$p_f$$ and a spot price $$p_s$$. We also defined the basis percentage, $$b_\%$$.

\begin{align*}
b & = p_f - p_s \\
b_\% & = \frac{p_f - p_s}{p_s}.
\end{align*}

We showed that when the basis is positive, traders can receive a fixed interest rate by shorting futures and buying spot asset, i.e. shorting the basis.

Here, we expand our analysis to leveraged basis trades and perp funding rate trades, and find conditions for which a trader should trade the basis rather than lend USD.

Basis trades offer a fixed-interest payoff structure and provide a market-neutral profit opportunity. Due to the basis’ low risk, it is worthwhile to ask: is there a lever through which traders can increase the trade’s return while also increasing the trade’s risk? It turns out there is: leveraged basis trading through spot margin lending.

### Conclusion

In this second part of the Basis Basics series, we demonstrate a number of extensions to the simple basis trades given in Part 1. First, we discuss how leveraged basis trades can yield higher returns, but these returns come at the cost of increased basis risk. Second, we examine the relationship between fixed-rate loans and fixed-expiry basis trades, showing that they are similar but somewhat distinct, and give practical guidance on when to trade the basis rather than lend. Finally, we perform a similar analysis for perpetual futures, demonstrating their similarity to variable-interest loans and providing guidance on when to trade the funding rate rather than lend.

Basis trading is a unique form of trading, and although it can partially be replicated via lending, basis trading still has its own unique set of risk and return profiles. Traders should practice proper risk management when speculating on the basis, especially when doing so with leveraged positions.