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What is a Buying Basis?

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  • Written By: Malcolm Tatum
  • Edited By: Bronwyn Harris
  • Last Modified Date: 29 October 2016
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In general, a buying basis is understood to be the calculation of the difference between the revenue that can be generated with a futures contract and the actual price associated with a cash commodity. Determining the buying basis can help an investor determine which type of purchase approach would be the best move, given the current circumstances of the market, as well as projections of how the market will be performing at the point in time when the futures would be due.

To understand how to properly ascertain the buying basis, it is necessary to understand what is meant by cash commodities and futures contracts. Essentially, a cash commodity is the actual physical item that is offered for sale. Sometimes referred to as actuals, this type of physical commodity can take on a variety of forms. Products such as corn or soybeans are examples of cash or physical commodities. Precious metals such as gold and silver also qualify as this type of commodity. Even items such as Treasury bonds meet the basic requirements to be thought of as a physical commodity.

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The second type of purchase or sale that is involved in calculating a buying basis is the futures contract. This type of contract basically creates an agreement for one investor to buy an option that is being sold by another investor. The difference is that with a futures agreement, payment is deferred to another specified point in time, rather than immediately. Second, the actual cost for the commodity may be at an amount that is different from the current market value. The idea behind a futures contract is to be able to acquire the asset at a price that may or may not be competitive today, but is anticipated to be very lucrative on the date that payment is to be rendered.

When determining the buying basis for an investment opportunity, the task of the investor is to decide if a greater profit will be realized from paying a particular price today, or entering into a covenant to pay a different prices at a later date. Much of the decision rests with the anticipated performance of the asset. If the anticipation is that market conditions will result in the value of the asset increasing significantly by the date of maturity, then paying a price that is slightly higher than the current market price may be a good idea. On the other hand, if the future performance of the asset is anticipated to be somewhat modest, there may be no real point in paying more than the current market rate for the investment.

Projecting the best course of action using the buying basis can also be helpful for the investor who anticipates having access to greater assets at a later date. If that is the case, the investor may determine that the buying basis indicates that securing an asset by means of a futures contract may be wiser. This is especially true if the investor would prefer to use current resources for other purposes and rely upon other investments to pay off before the date to settle the contract arrives.

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