You'll often notice the Nifty future trading a little above — or below — the Nifty spot. That gap isn't random; it follows from a simple idea called cost of carry. Understanding it explains the terms basis, contango and backwardation. For learning only.
Fair value: the cost of carry
Buying a future lets you control the underlying now but pay later. So its fair price is the spot plus the cost of "carrying" the position to expiry — mainly the interest on the money you didn't pay yet, minus any dividends you miss. In short: Fair price = Spot × e(r − q) × T, where r is the interest rate, q the dividend yield, and T the time to expiry. For a typical index over a month, that's a small premium over spot.
The basis
The basis is simply the futures price minus the spot. When the future is above spot, the basis is positive; below, negative. Comparing the actual basis with the theoretical cost of carry tells you whether the future is "expensive" or "cheap" versus fair value.
Contango and backwardation
- Contango — the future trades above spot (positive basis). This is the normal state for index futures, reflecting the cost of carry.
- Backwardation — the future trades below spot (negative basis). It can signal bearishness (traders paying to be short), heavy expected dividends, or tight supply in a commodity.
Convergence at expiry
Whatever the basis along the way, it shrinks to zero at expiry — on the last day the future and the spot must meet, because the contract settles at the spot. The basis is really just the carry that's left, melting away as expiry nears.
How to use it
A future far from fair value is rarely free money once funding and dividends are counted. But an unusually wide or negative basis is a useful sentiment clue. See the numbers for any contract in the futures calculator, and the basics in futures explained with a real Nifty example.
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