Short The Basis

You run a company that makes brain pills, supplements you advertise as "powerful mind builders and IQ enhancers." The pills mostly consist of sugar and soy. As such, you buy a lot of both commodities. But, looking at weather reports, it seems like there might be a shortage in the futures, with prices likely to go up. You'd like to lock in a price now for the sugar and soy you'll need for your upcoming production; that way, your expenses don't spike if prices for the commodities go up.

Time to short the basis. It's a futures strategy that allows to you to guarantee a reasonable price in the future. You're going to need the sugar and soy for your manufacturing process, so you want to lock in a price you can handle.

So, instead of waiting until you need the items and paying spot prices (the prices you would pay if you went out into the market when you needed the commodities), you purchase a futures contract now, set to deliver at the point you will need the sugar and the soy. You now know the price you are going to pay for those commodities.

When a party shorts the basis, they purchase a futures contract as a hedge against some future commitment to deliver the underlying commodity. In this case, the future commitment was the manufacturing process for the brain pills. It could also come up in a situation where you were a middleman for the commodity.

Like...say you have a side business providing sugar to a manufacturer of diet pills. You buy the sugar on the open market and sell to your diet pill clients. You need to deliver the sugar to them every month, i.e. you have a commitment to deliver that commodity. You can use the short the basis technique to hedge against price jumps...locking in prices today with a futures contract, so you have a guaranteed price for the sugar you're selling down the line.