Basket Option

<body onLoad="MM_checkPlugin('Shockwave Flash','','http://www.riskglossary.com/default_nofl.htm',false);return document.MM_returnValue" stylesrc="../_private/template.htm" language="Javascript1.2" bgcolor="#FFFFFF" link="#669933" vlink="#000000" alink="#000000"> <div align="left"> <table border="0" cellpadding="0" cellspacing="0" style="border-collapse: collapse" bordercolor="#111111" width="100%" id="table1"> <tr> <td width="740"> <table border="0" cellpadding="0" cellspacing="0" style="border-collapse: collapse" bordercolor="#111111" width="100%" height="37" id="table2"> <tr> <td height="35" width="100%"> <table border="0" cellspacing="0" style="border-collapse: collapse" bordercolor="#111111" width="100%" cellpadding="0" id="table3"> <tr> <td width="100%" align="left" valign="top"> <p class="header_gold">Basket Option</td> <td width="45" align="right" valign="bottom"> <a onmouseover="var img=document['fpAnimswapImgFP11'];img.imgRolln=img.src;img.src=img.lowsrc?img.lowsrc:img.getAttribute?img.getAttribute('lowsrc'):img.src;" onmouseout="document['fpAnimswapImgFP11'].src=document['fpAnimswapImgFP11'].imgRolln" href="javascript:void(0)"> <map name="FPMap6"> <area href="http://www.contingencyanalysis.com" shape="rect" coords="1, 0, 44, 11" target="_top"> </map> <img border="0" src="../images/home.gif" usemap="#FPMap6" id="fpAnimswapImgFP11" name="fpAnimswapImgFP11" dynamicanimation="fpAnimswapImgFP11" lowsrc="../images/home_down.gif" width="45" height="12"></a></td> </tr> </table> </td> </tr> <tr> <td width="100%" bgcolor="#CC9966" height="2"> <img border="0" src="../images/blank_2x2.gif" width="2" height="2"></td> </tr> <tr> <td width="0%" valign="top" bgcolor="#FFFFCC"> <table border="0" style="border-collapse: collapse" bordercolor="#111111" width="100%" cellpadding="0" cellspacing="1" id="table4"> <tr> <td width="0%" align="left" valign="top"> <p class="header2_black">Explained:<br> <img border="0" src="../images/blank_1x100.gif" width="100" height="1"></td> <td width="0%" align="left" valign="top"><p class="word_list"> <a href="#basket option">basket option</a><br> <img border="0" src="../images/blank_1x160.gif" width="160" height="1"></td> <td width="100%" align="left" valign="top"><p class="word_list"> <br> <img border="0" src="../images/blank_1x160.gif" width="160" height="1"></td> </tr> </table> </td> </tr> </table> <table border="0" cellpadding="0" style="border-collapse: collapse" bordercolor="#111111" width="310" align="right" id="table5"> <tr> <td align="right" width="9" height="14"></td> <td width="300" height="14"> <font size="2"> </font><font size="4"> </font></td> </tr> <tr> <td align="right" width="9"> </td> <td width="300"> <script type="text/javascript"></script> <script type="text/javascript" src="http://pagead2.googlesyndication.com/pagead/show_ads.js"> </script>  </td> </tr> </table> <p class="body">A <b><a name="basket option">basket option</a></b> is an option whose payoff is linked to a portfolio or "basket" of underlier values. The basket can be any weighted sum of underlier values so long as the weights are all positive. Basket options are usually cash settled. A call option on France's CAC 40 stock index is an example of a basket option. </p> <p class="body">Basket options are popular for hedging foreign exchange risk. A <a href="../articles/corporation.htm">corporation</a> with multiple currency exposures can hedge the combined exposure less expensively by purchasing a basket option than by purchasing options on each currency individually.</p> <p class="body">Basket options are often priced by treating the basket's value as a single underlier and applying standard option pricing formulas. An error is introduced by the fact that a weighted sum of lognormal random variables in not lognormal, but this is generally modest.</p> <table border="0" cellpadding="0" cellspacing="0" style="border-collapse: collapse" bordercolor="#111111" width="100%" id="table6"> <tr> <td height="30" valign="bottom" colspan="2"> <p class="header2_black">Related Internal Links</td> </tr> <tr> <td colspan="2" bgcolor="#CC9966" height="2"> <img border="0" src="../images/blank_2x2.gif" width="2" height="2"></td> </tr> <tr> <td bgcolor="#FFFFCC" colspan="2"> <table border="0" cellspacing="0" style="border-collapse: collapse" bordercolor="#111111" width="100%" cellpadding="6" id="table7"> <tr> <td width="100%"> <p class="explanatory_text"> <img border="0" src="../images/bullet_link_glossary.gif" width="26" height="15"><strong style="font-weight: 400"><a href="../articles/derivative_instrument.htm">d</a></strong><a href="../articles/derivative_instrument.htm"><strong style="font-weight: 400">erivative instrument</strong></a><strong style="font-weight: 400"> An instrument which derives its value from the value of other financial instruments. Article includes a list of vanilla and exotic derivatives.</strong></p> <p class="explanatory_text"> <img border="0" src="../images/bullet_link_glossary.gif" width="26" height="15"><a href="../articles/multifactor_option.htm">multifactor option</a> An option whose payoff depends upon the performance of two or more underliers.</p> <p class="explanatory_text"> <img border="0" src="../images/bullet_link_glossary.gif" width="26" height="15"><strong style="font-weight: 400"><a href="../articles/option_pricing_theory.htm">option pricing theory</a> The body of financial theory used by financial engineers to value options and other derivative instruments.</strong></td> </tr> </table> </td> </tr> <tr> <td height="30" valign="bottom" colspan="2"> <p class="header2_black">Sponsored Links</td> </tr> <tr> <td colspan="2" bgcolor="#CC9966" height="2"> <img border="0" src="../images/blank_2x2.gif" width="2" height="2"></td> </tr> <tr> <td bgcolor="#FFFFCC" width="75"> <img border="0" src="../images/ad_side_banner_1.jpg" width="103" height="285"></td> <td bgcolor="#FFFFCC" width="99%"> <script type="text/javascript"></script> <script type="text/javascript" src="http://pagead2.googlesyndication.com/pagead/show_ads.js"> </script>  </td> </tr> <tr> <td height="30" valign="bottom" colspan="2"> <p class="header2_black">Related Books</td> </tr> <tr> <td colspan="2" bgcolor="#CC9966" height="2"> <img border="0" src="../images/blank_2x2.gif" width="2" height="2"></td> </tr> <tr> <td bgcolor="#FFFFCC" colspan="2"> <table border="0" cellspacing="0" style="border-collapse: collapse" bordercolor="#111111" width="100%" cellpadding="6" id="table8"> <tr> <td width="100%"> <p class="explanatory_text">Haug (<a target="_blank" href="http://www.riskbook.com/link/haug_e_(1997).htm">1997</a>) and Bryis et al (<a target="_blank" href="http://www.riskbook.com/link/briys_et_al_(1998).htm">1998</a>) describes classic pricing methodologies. Taleb (<a target="_blank" href="http://www.riskbook.com/link/taleb_n_(1996).htm">1996</a>) has a chapter on basket options, primarily from a trading and dynamic hedging perspective. Das (<a target="_blank" href="http://www.riskbook.com/link/das_satyajit_(2003).htm">2004</a>) provides an in-depth discussion of baskets from a trader's perspective. </p> <table border="0" cellpadding="4" cellspacing="0" style="border-collapse: collapse" bordercolor="#111111" width="100%" id="table9"> <tr> <td width="100" align="left" valign="top"> <map name="FPMap571"> <area target="_blank" href="http://www.riskbook.com/link/haug_e_(1997).htm" shape="rect" coords="0, 0, 100, 124"> </map> <img border="0" src="../images/book_haug_espen_(1997)_125.gif" usemap="#FPMap571" width="101" height="125"></td> <td align="left" valign="top"> <table border="0" cellpadding="1" cellspacing="0" style="border-collapse: collapse" bordercolor="#111111" width="100%" id="table10"> <tr> <td width="90%" colspan="3"> <p class="title"> <a target="_blank" href="http://www.riskbook.com/link/haug_e_(1997).htm"> <font size="2">Complete Guide to </font><br> Option Pricing Formulas </a></td> </tr> <tr> <td colspan="3"> <p class="author"><b><span class="verdana10bold">Espen G. Haug </span></b></td> </tr> <tr> <td width="10%"><map name="FPMap572"> <area target="_blank" href="http://www.riskbook.com/main/ratings.htm" shape="rect" coords="0, 0, 89, 15"> </map> <img border="0" src="../images/star_5.gif" usemap="#FPMap572" width="90" height="16"></td> <td width="10%" class="author">quality</td> <td width="70%"> <p class="author"> </td> </tr> <tr> <td width="10%"><map name="FPMap573"> <area target="_blank" href="http://www.riskbook.com/main/ratings.htm" shape="rect" coords="0, 0, 89, 15"> </map> <img border="0" src="../images/tech_2.gif" usemap="#FPMap573" width="90" height="16"></td> <td width="10%" class="author">technical</td> <td width="70%">  </td> </tr> <tr> <td width="10%"> <p class="author">1997</td> <td width="10%"> </td> <td width="70%"> <p align="center"><map name="FPMap574"> <area target="_blank" coords="0, 0, 145, 19" shape="rect" href="http://www.riskbook.com/link/haug_e_(1997).htm"> </map> <img border="0" src="../images/pointer_review.gif" usemap="#FPMap574" width="146" height="20"></td> </tr> </table> </td> </tr> </table> <table border="0" cellpadding="4" cellspacing="0" style="border-collapse: collapse" bordercolor="#111111" width="100%" id="table11"> <tr> <td width="100" align="left" valign="top"> <map name="FPMap575"> <area target="_blank" coords="0, 0, 91, 124" shape="rect" href="http://www.riskbook.com/link/briys_et_al_(1998).htm"> </map> <img border="0" src="../images/book_briys_et_al_(1998)_125.gif" usemap="#FPMap575" width="92" height="125"></td> <td align="left" valign="top"> <table border="0" cellpadding="1" cellspacing="0" style="border-collapse: collapse" bordercolor="#111111" width="100%" id="table12"> <tr> <td width="90%" colspan="3"> <p class="title"> <a target="_blank" href="http://www.riskbook.com/link/briys_et_al_(1998).htm"> Options, Futures, and Exotic Derivatives</a></td> </tr> <tr> <td colspan="3"> <p class="author"> <img border="0" src="../images/text_snippet_2.gif" width="254" height="14"></td> </tr> <tr> <td width="10%"><map name="FPMap576"> <area target="_blank" href="http://www.riskbook.com/main/ratings.htm" shape="rect" coords="0, 0, 89, 15"> </map> <img border="0" src="../images/star_5.gif" usemap="#FPMap576" width="90" height="16"></td> <td width="10%" class="author">quality</td> <td width="70%"> <p class="author"> </td> </tr> <tr> <td width="10%"> <img border="0" src="../images/tech_4.gif" usemap="#FPMap577" width="90" height="16"><map name="FPMap577"><area target="_blank" href="http://www.riskbook.com/main/ratings.htm" shape="rect" coords="0, 0, 89, 15"></map></td> <td width="10%" class="author">technical</td> <td width="70%">  </td> </tr> <tr> <td width="10%"> <p class="author">1998</td> <td width="10%"> </td> <td width="70%"> <p align="center"><map name="FPMap366"> <area target="_blank" coords="0, 0, 145, 19" shape="rect" href="http://www.riskbook.com/link/briys_et_al_(1998).htm"> </map> <img border="0" src="../images/pointer_review.gif" usemap="#FPMap366" width="146" height="20"></td> </tr> </table> </td> </tr> </table> <span style="font-family: Times New Roman; 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