Basis = spot price-futures price, that is, basis is the difference between spot price and futures price.

Compared with the fluctuation range of spot price and futures price itself, the fluctuation range of basis is small and relatively stable.

The principle of hedging is to use relatively stable basis to avoid risks and lock in profits.

In an ideal state, the "profit/loss" in the spot market and the "loss/profit" in the futures market completely cancel each other out.

Successful hedging will not generate additional profits or losses.

However, due to practical reasons, the profits and losses generated by the two markets are not exactly the same, resulting in additional profits or losses.

Taking LZ "buy hedging" as an example, theoretically speaking, at the beginning and end of hedging,

If the basis is reduced, not only the hedging is successful, but also additional profits can be obtained;

On the other hand, hedging is not completely successful, resulting in losses.

Influencing factors of basis difference:

Theoretically, we should look for futures contracts that completely match the spot positions for hedging transactions.

But in fact, due to the differences in "variety, term and quantity", it is impossible to find a completely matching futures contract.

Therefore, the cash flow cannot be completely locked, which will lead to basis risk.