What Is a Basket Option?

Malcolm Tatum
Malcolm Tatum

A basket option is a type of security option that is backed by a collection of assets. The range of assets that are included in the underlying basket may include various securities, commodities and even a number of different currencies. Considered a viable means of consolidating several different investments into one simple option, the basket option can be a lucrative arrangement for buyers and sellers alike.

Man climbing a rope
Man climbing a rope

One of the more common examples of a basket option will include several different currencies as part of the offering. The idea is often to collect these holdings and offer them for sale as a means of easily generating funds that are in one particular currency. For example, a seller may create a basket option that includes British pounds as well as Euros, and offer the option to a US based investor at a price that is denominated in US dollars. Depending on the current rate of exchange with all the currencies involved, this type of sale could be advantageous for both the buyer and seller over time.

The nature of a basket option makes it an ideal method of hedging the assets that are included in the combination. Typically, the range of assets are such that while some may carry a higher degree of risk than others, the variety helps to minimize the possibility of loss. This is because the selection of assets used as underlying securities for the basket option is so varied that it is highly unlikely that all of them would begin to decrease in value at the same time.

With most basket option arrangements, the option comes with a strike price. Often, that price is set after determining the value of the currencies and other securities included in the basket and allowing for the conversion rate that applies, depending on the type of currency the buyer will use to complete the purchase. For the buyer, choosing to purchase a basket option means the ability to acquire a number of different types of assets at a combined price that is less than the amount he or she would pay to purchase each asset individually. This approach means that there is a good chance the buyer generates returns on the deal almost immediately.

Sellers can benefit from the creation of a basket option as a means of easily removing certain assets from the investment portfolio in order to generate funds that are used to purchase other investments that are more conducive to the seller’s plans for the portfolio. Typically, the assets included in the option are a mixed bag, not only in type but also in terms of future performance. This does not mean that the assets included in the basket are unlikely to generate returns in the future; does mean that while some may be riskier than others, some are likely to generate a return that is a little less than the investor would like. Buyers who investigate the underlying assets and find that the projected returns are attractive, given the degree of volatility inherent in those assets, are still likely to generate enough return to find the deal worth the time and effort.

Malcolm Tatum
Malcolm Tatum

After many years in the teleconferencing industry, Michael decided to embrace his passion for trivia, research, and writing by becoming a full-time freelance writer. Since then, he has contributed articles to a variety of print and online publications, including wiseGEEK, and his work has also appeared in poetry collections, devotional anthologies, and several newspapers. Malcolm’s other interests include collecting vinyl records, minor league baseball, and cycling.

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