Net Basis

What Is Net Basis?

Net basis measures the carry-adjusted price difference between a physical (cash) bond and the corresponding futures contract into which that bond could be delivered. It refines the simpler gross basis (cash price minus futures invoice price) by subtracting the carry — the net financing cost of holding the bond from today to the futures delivery date, which equals coupon income minus repo financing cost.

Formally:

Net Basis = Gross Basis − Carry Gross Basis = Cash Price − (Futures Price × Conversion Factor) Carry = Accrued Coupon Income − Repo Cost

The conversion factor is a standardization multiplier assigned by the exchange to normalize each deliverable bond to the futures contract's notional coupon. Because different bonds have different coupons and maturities, the conversion factor creates a theoretical equivalence — but in practice, one bond is almost always cheapest-to-deliver (CTD) into the contract, and it is typically the bond with the most negative net basis.

Net basis is expressed in 32nds of a point in U.S. Treasury markets (where one point = 1% of face value), so a net basis of –4/32 means the cash bond is 4/32 cheaper than the implied futures price after accounting for carry.

Why It Matters for Traders

Net basis is the foundational tool for basis trading — one of the most widely employed relative-value strategies in fixed income. Hedge funds and bank proprietary desks construct long cash bond / short futures (positive carry position) or short cash bond / long futures trades depending on whether net basis appears rich or cheap relative to historical norms.

The CTD bond drives futures pricing: as long as the net basis of the CTD is negative (meaning it is cheaper to deliver the cash bond than to close the futures), the arbitrage channel holds prices in line. When net basis becomes significantly positive for all deliverable bonds — meaning the futures contract is theoretically "too cheap" — this can signal stress in repo markets, forced dealer balance sheet reduction, or a short squeeze in futures positions.

During risk-off episodes, the relationship between cash Treasuries and futures can dislocate, creating large net basis moves. These dislocations are direct inputs to understanding convexity hedging flows and dealer risk management.

How to Read and Interpret It

• Net basis close to zero: Normal market functioning; arbitrage is keeping cash and futures prices aligned.
• Net basis sharply positive: Futures are cheap relative to cash; often signals repo market stress, balance sheet constraints at dealers, or large short positioning in futures.
• Net basis deeply negative: The cash bond is extremely cheap to deliver; unusual and often signals forced selling of specific securities or a liquidity premium in the cash market.
• CTD switch: When rising yields shift the CTD identity from one bond to another, futures prices reprice discontinuously — a critical risk for those running basis positions.

Historical Context

During the March 2020 COVID liquidity crisis, U.S. Treasury net basis blew out dramatically as hedge funds that had put on leveraged basis trades (long cash Treasuries, short Treasury futures) were forced to unwind simultaneously. The net basis on 10-year Treasury futures widened to levels not seen since the 2008 financial crisis — in some cases exceeding 10–15/32 on a gross basis — as repo financing dried up and margin calls forced liquidation. The Federal Reserve ultimately intervened with over $1 trillion in repo operations and Treasury purchases to restore normal basis relationships. This episode highlighted the systemic risk embedded in what appeared to be a "riskless" arbitrage.

Limitations and Caveats

Net basis analysis requires precise modeling of repo rates for each deliverable bond, which vary by security and change daily. The optionality embedded in futures contracts — the short side's delivery timing and bond selection options — means net basis is never truly zero even in frictionless markets; these embedded options have value that must be separately modeled. Additionally, basis trades require significant leverage to generate meaningful returns, making them highly sensitive to margin calls and repo market disruptions.

What to Watch

• GC (general collateral) repo rates vs. special repo rates for CTD bonds — widening spreads signal basis stress.
• Open interest in Treasury futures around delivery months for signs of squeeze dynamics.
• Fed balance sheet operations and Treasury General Account drawdowns that affect reserve levels and repo market functioning.
• SOFR vs. Fed funds rate spread as an indicator of broader secured funding market stress.