Hi David,
I do not really understand the concept.
You said that the strenthening of the basis is favorable for a short hedge.
In a short hedge position, I will be selling the future contract in order to hedge for the underlying that I have. So if the spot price increases, there is no gain no?

thank you David

Hi mkparis,

I trust i emphasized *unexpected* strengthening of the basis? You are correct in the first sense; another way of saying is, if the hedge correctly predicts the basis (difference between the futures price and spot), he/she can perfectly hedge (no net gain, as you say).

But the problem (basis risk) is that the future spot and future forward can’t be perfectly predicted. So, *unexpected* strengthening is when the spot increases more than the hedger predicted (more than the hedge implied), so you profit on the increment (unexpected realized spot - expected spot).

David