Basis in Nifty Futures: Cost of Carry and Convergence to Expiry

What Basis Actually Means

Basis is simply the futures price minus the spot price of the same underlying at the same moment. If Nifty spot is at 23,400 and the current month Nifty future is quoting 23,470, the basis is positive 70 points. Some desks define it the other way round as spot minus futures, so always check the sign convention, but on Indian index futures the practical reality is that the future trades a little above spot, giving a positive basis.

A positive basis where futures sit above spot is called contango, and a negative basis where futures sit below spot is called backwardation. Index futures in India are almost always in mild contango because of the cost of carry, which we work through below. You mainly see backwardation around heavy dividend dates or when traders aggressively short the future expecting a fall, which pushes the future below spot.

Basis is not a vague sentiment gauge. It has an arithmetic anchor, the cost of carry. When the actual basis drifts far from the fair carry value, arbitrage desks step in and trade it back, which is why on liquid contracts the basis stays close to its theoretical level for most of the contract's life.

The Cost of Carry: Why Basis Exists

A futures contract is a promise to settle later. If you hold the future instead of buying the underlying stocks today, you keep your cash and can earn interest on it, but you also give up the dividends those stocks would have paid. The fair futures price reflects both effects. The standard fair value formula is Futures = Spot times (1 + r times t) minus expected dividends, where r is the annual risk free rate and t is the time to expiry as a fraction of a year.

Rearranged, the fair basis equals Spot times r times t minus dividends. The interest term pushes the future above spot, and the dividend term pulls it back down. For a broad index like Nifty, dividends are spread thinly across the year, so for most weekly and monthly contracts the interest term dominates and the basis is positive. Near a cluster of ex-dividend dates the dividend term can briefly exceed the interest term and flip the basis negative.

Worked Example: Nifty Fair Basis With Cost of Carry

Assume Nifty spot is at 23,400, the monthly contract has 30 days to expiry, the financing rate is 7 percent per year, and dividends expected from index constituents over those 30 days are worth about 14 index points. These numbers are illustrative, not live quotes. The interest component is 23,400 times 0.07 times 30 divided by 365, which equals about 134.6 points. Subtract the 14 dividend points and the fair basis is roughly 120 points.

That makes the fair futures price about 23,520 (23,400 plus 120). If the actual Nifty future is trading at 23,545, it is about 25 points rich to fair value. If it is trading at 23,495, it is about 25 points cheap. The fair value tells you whether the current premium is normal carry or something the market is paying extra for, such as strong bullish positioning or a temporary financing squeeze.

Convergence: Basis Must Hit Zero at Expiry

The single most dependable property of basis is convergence. As the contract counts down to expiry, the time value t in the carry formula shrinks toward zero, so the fair basis shrinks too. On the morning of expiry there is almost no carry left, so the future trades within a point or two of spot. At settlement the basis is forced to exactly zero because the contract settles against the underlying's value, not against any independent futures quote.

On NSE, index futures are cash settled. There is no delivery of a basket of shares. The final settlement price for an index future is the volume weighted average of the underlying index over a defined window of the last trading session, so by definition the future and the index converge to the same number. This is why a 120 point basis a month out is not a mispricing you can pocket risk free. It is carry that decays predictably to zero, and your financing cost over the month is the mirror image of that decay.

NSE Expiry Mechanics That Shape Basis

Indian F&O follows a fixed expiry calendar, and the cycle matters for basis because each contract has its own time to expiry and therefore its own carry. Nifty has weekly and monthly expiries, while Bank Nifty and single stock futures are monthly. Different exchanges and indices use different weekdays for weekly expiry, and SEBI has periodically rationalised the weekly expiry day, so always confirm the current expiry weekday for the specific index on the exchange before you trade a short dated basis.

Because each expiry has a different t, the near month future and the far month future carry different basis. The far month always has a larger fair basis simply because it has more days of carry. The gap between the two, the calendar spread, is itself a basis trade: it isolates the cost of carry between two expiry dates and is far less exposed to a directional move in the index than an outright position.

• Near month basis is small close to expiry and decays fastest in the final week.
• Far month basis is larger because more days of carry are priced in.
• Around index reconstitution and large ex-dividend dates, the dividend term in the carry jumps and can squeeze or invert the basis.
• Liquidity is deepest in the near month, so quoted basis there is the most reliable; far month and stock futures can show wider, staler basis.

Cash and Carry Arbitrage in Practice

When the future is meaningfully richer than fair carry, arbitrage desks run a cash and carry trade: buy the underlying in the cash market and sell the future. They lock in the basis and unwind at expiry when the two converge. When the future is cheaper than fair carry they run the reverse, which is harder for retail because it needs the stock to be available to short. The presence of these desks is precisely why the actual basis hugs the fair carry line on liquid names.

For a single stock example, take Reliance with spot at 2,900 and a monthly future at 2,930, a basis of 30. The future lot size is set by the exchange in contract value terms, so check the current lot before sizing. If fair carry says the basis should be about 18, the future is roughly 12 rich. A cash and carry desk buys Reliance shares and sells the future to capture that 12, but after brokerage on both legs, exchange charges, GST on charges, STT on the sell side, and the financing cost of buying the shares, the net edge on a 12 point gap is thin. Retail traders almost never beat the desks on pure arbitrage because their cost stack is higher.

Basis Risk When You Hedge

Basis risk is the risk that the basis moves against you while you hold a hedge. Suppose you own a portfolio of large cap stocks and short Nifty futures to protect against a market fall. Your hedge is only perfect if your portfolio moves exactly like the index. In reality your stocks and the index diverge, and the basis between them shifts, so the hedge under or over performs. The leftover wobble is basis risk.

Even a textbook hedge on the index itself carries basis risk over time, because the futures basis can widen or narrow before expiry for financing or sentiment reasons. If you put the hedge on when the future is at a fat premium and the premium collapses faster than carry alone would explain, the short future gains more than the spot fall, helping you. If you short at a thin premium and it widens, the hedge lags. The way to neutralise this is to hold to expiry, where convergence guarantees the basis lands at zero.

How to Read Basis as a Signal

Because the fair basis is computable, the useful signal is the gap between actual basis and fair carry, not the raw basis number. A future trading well above fair carry tells you traders are paying up to be long, often a crowded bullish positioning that can unwind sharply. A future at or below fair carry, or in outright backwardation away from dividend dates, often reflects aggressive short hedging or bearish positioning.

Pair the basis read with open interest and rollover data near monthly expiry. When traders roll positions from the expiring contract to the next month, the rollover cost is essentially the basis difference between the two contracts, and a high rollover at a rich basis confirms strong conviction in the direction being carried forward.

Taxes and Costs on Basis Trades

In India, F&O trading is treated as business income, not capital gains. Profits from futures and options, including basis and calendar spread trades, are added to your business income and taxed at your applicable slab rate. This is different from buying the cash share, where short term gains are taxed at 20 percent and long term gains above 1.25 lakh rupees at 12.5 percent. A cash and carry arbitrage therefore has a split tax treatment: the cash leg follows capital gains rules and the futures leg follows business income rules, which complicates the after tax maths.

On the cost side, STT applies on the sell side of futures, brokerage applies per leg, and there are exchange transaction charges, GST on those charges, stamp duty, and SEBI charges. Because basis edges are small, these frictions decide whether a trade is actually positive. Always run the full cost stack, including the financing cost of any cash position, before treating a basis gap as profit. Confirm current STT and charge rates on the exchange and broker before relying on a specific number.

• F&O gains: business income, taxed at slab rate, not capital gains.
• Cash leg of an arbitrage: capital gains rules, STCG 20 percent or LTCG 12.5 percent above 1.25 lakh.
• STT on futures: charged on the sell side; verify the current rate before sizing.
• Other costs: brokerage per leg, exchange charges, GST on charges, stamp duty, SEBI fees, and financing cost on any long cash position.

Common Mistakes With Basis

The biggest mistake is treating a wide basis as free profit. A 120 point Nifty premium a month out is mostly carry that decays to zero, not a gift. The second mistake is ignoring costs, where STT, brokerage, GST, and financing quietly erase a small arbitrage edge. The third is forgetting dividends, since a near term cluster of ex-dividend dates can shrink or invert the basis and make a normal premium look abnormal.

A further trap is comparing the future to a stale spot. Basis must be measured against the live underlying at the same instant, because even a few seconds of lag during fast moves can manufacture a phantom basis that vanishes on the next tick. Use synchronised quotes, and on a futures contract always check the exact lot size and current expiry day before you size a position.

Sources and Further Reading

For authoritative contract specifications, expiry calendars and settlement rules, refer to NSE India and Zerodha Varsity. Always confirm current lot sizes, the expiry weekday, STT and other charges, and settlement mechanics on the official source before you trade.

Sources and Further Reading

For authoritative data and further reading on this topic, refer to NSE India, Zerodha Varsity and MCX (Multi Commodity Exchange). Always confirm current rules, rates and contract specifications on the official source before you trade.