Basket option
A basket option is a financial derivative, more specifically an exotic option, whose underlying is a weighted sum or average of different assets that have been grouped together in a basket. For example, an index option, where a number of stocks have been grouped together in an index and the option is based on the price of the index.[1][2]
Unlike a rainbow option which considers a group of assets but ultimately pays out on the level of one, a basket option is written on a basket of underlying assets but will pay out on a weighted average gain of the basket as a whole. [3]
Like rainbow options basket options are most commonly written on a basket of equity indices, though they are frequently written on a basket of individual equities as well. For example, a call option could be written on a basket of ten healthcare stocks, where the basket was composed of ten stocks in weighted proportions.
The strike price Xbasket is usually set at the current value of the basket (at-the-money), and the payoff profile will be max(Sbasket - Xbasket) where Sbasket is a weighted average of n asset prices at maturity, and each weight represents the percentage of total investment in that asset. [4]
Pricing and valuation
Basket options are usually priced using an appropriate industry-standard model (such as Black–Scholes) for each individual basket component, and a matrix of correlation coefficients applied to the underlying stochastic drivers for the various models. While there are some closed-form solutions for simpler cases (e.g. two-color European rainbows)[5], and some analytical approximations [6], the general case must be approached with Monte Carlo or binomial lattice methods.
See also
References
- ^ "Basket option". The Financial Engineer. 2014. Retrieved 14 December 2016.
- ^ Hakala, Jürgen; Wystup, Uwe (2008). "FX Basket Options" (pdf). Frankfurt School of Finance & Management. p. 4. Retrieved 14 December 2016.
- ^ Choudhry, Moorad. Bond and money markets: strategy, trading, analysis. Butterworth-Heinemann, 2003. p.838
- ^ Zhang, Peter G. Exotic options: a guide to second generation options. 1997. p553
- ^ Rubinstein, Mark. Exotic options. No. RPF-220. University of California at Berkeley, 1991. URL:http://www.haas.berkeley.edu/groups/finance/WP/rpf220.pdf
- ^ Alexander, Carol, and Aanand Venkatramanan. "Analytic Approximations for Multi‐Asset Option Pricing." Mathematical Finance 22.4 (2012): 667-689.
 | This economics-related article is a stub. You can help Wikipedia by expanding it. |