Basis risk is the risk that the cash–futures price relationship changes unexpectedly after a hedge is established and before it is lifted. Basis is the observed difference between a cash price and a related futures price; in the common commodity-futures convention, it is calculated as cash price minus futures price. Basis risk is the uncertainty about how that difference will change. A futures hedge can therefore reduce outright price exposure without fixing the final economic price exactly, because the cash and futures legs may not move point-for-point. Importantly, a large absolute basis is not necessarily high basis risk: a large but stable relationship may be more predictable than a smaller basis that changes sharply.
The hedge transfers risk rather than eliminating it
Consider a producer who sells futures against an expected physical sale. If the local cash price later falls by $1.10 per unit while the futures contract falls by $1.00, the futures gain offsets most of the cash-market decline, but the basis has weakened by $0.10. The producer's net hedged selling price is therefore $0.10 lower than it would have been if basis had remained unchanged. For a short hedger, an unexpectedly stronger basis improves the hedge outcome; an unexpectedly weaker basis hurts it. Long hedgers face the opposite exposure.
Convergence is narrower than it looks
For physically delivered futures, the futures price and the price of the deliverable commodity tend to converge as expiration approaches, but that does not imply that every hedger's local basis must become zero. Basis can reflect differences in location, quality or grade, product form, timing, freight, storage and local supply-and-demand conditions. A hedge may also be closed before expiration or may use a related, rather than identical, futures contract. Those mismatches can leave economically meaningful basis risk even when the futures contract itself is functioning normally and its deliverable market is converging.
For research and hedge design, the key variable is therefore the behavior of the basis over the intended hedge horizon, not merely the correlation between cash and futures prices. Historical basis stability, seasonality, delivery geography, contract month, grade or benchmark differences and stressed-market behavior can all matter. Basis risk is residual risk: the hedge may remove much of the broad market move while leaving the hedger exposed to changes in the relationship between the exposure being hedged and the instrument used to hedge it.