What is a Basket
A basket is a single unit of at least 15 stocks that are used in program trading, index fund management and currency portfolio management. Baskets are traded on both the NYSE and the CBOE for institutions and index arbitrageurs. Both instruments allow for the composite purchase of all of the stocks in the S&P 500 in a single trade.
BREAKING DOWN Basket
After the stock market crash in 1987, baskets were created to better facilitate institutional trading on the index. A basket option is a type of financial derivative with underlying assets with a weighted sum and average. These assets have been grouped together in a basket. A sample of such is index options wherein different stocks have been compiled together as an index. Instead of basing the price of the index on particular stocks, they are based on the average of the index’s underlying assets’ weighted sum and average.
There are some similarities between baskets and mutual funds. Some of their advantages include portfolio management, broad diversification and can sometimes require a relatively small investment base. But unlike mutual funds, the investor owns the investments that make up the basket, meaning he becomes the beneficiary of any capital gains, interest income and/or dividends.
Baskets with 15 or more stocks may be used for program trading. Program trading is used by hedge funds firms and other institutional investors looking for or using index arbitrage. Traders use program trading for two reasons. First, traders are allowed to trade a large number of stocks in a single time. Second, it lessens risk by flattening price discrepancies among different financial instruments within an index.
An index fund is also known as the index tracker. It is basically an exchange-traded fund (ETF) or a mutual fund with particular rules of construction that are followed no matter how the market conditions may be.
The most famous index fund is the S&P 500 Index Fund, which is based on the constructed rules by S&P Dow Jones Indices. Equity index funds like the S&P 500 Index Fund includes batches of stocks with the same characteristics. These characteristics include value, size, profitability and/or the physical location of the companies involved.
The market basket covers consumer goods. These consumer goods baskets define the Consumer Price Index (CPI). This basket tracks the movement of consumer good prices. The assets placed in these baskets may be divided according to personal goods and services, leisure goods, housing, tobacco, household items, and/or alcoholic drinks.
Other baskets are used to manage and define the Producer Price Index (PPI) and different types of commodity price indices.
A currency basket consists of particular currencies that differ in weight. A currency basket minimizes the risk of currency fluctuations by averaging the basket’s underlying currencies’ weights. Samples of currency baskets include the drawing rights of the International Monetary Fund and European Currency Unit.