How do I use a "basket" option?

By Bob Schneider AAA
A:

A basket option is an option with an underlying asset "basket" of securities, currencies or commodities. Basket options are a popular way to hedge portfolio risk. Meanwhile, using the basket option costs significantly less than buying an option on the individual components of the portfolio.



Basket options often are used as a cost-effective way for portfolio managers to consolidate multicurrency exposures. This works because a basket option offers the unique characteristic of a strike price based on the weighted value of the basket of currencies, calculated in the buyer's base currency. The buyer chooses the maturity of the option, the foreign currency amounts for the basket and the aforementioned strike price.



(For more on this topic, read Options Basics.)



This question was answered by Bob Schneider.



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