Basket Options

Basket options are a type of option whose underlying asset is a basket of commodities, securities, or currencies. A basket option 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 popular for hedging foreign exchange risk. A corporation with multiple currency exposures can hedge the combined exposure less expensively by purchasing a basket option than by purchasing options on each currency individually.The basket option buyer purchases the right, but not the obligation, to receive designated currencies in exchange for a base currency, either at the prevailing spot market rate or at a prearranged rate of exchange. A basket option is generally used by multinational corporations with multicurrency cash flows since it is generally cheaper to buy an option on a basket of currencies than to buy individual options on each of the currencies that make up the basket.