Basket options are options on a basket of assets. The assets can be stocks, commodities, indices and other financial securities. A commonly traded basket option is a vanilla call/put option on a linear combination of assets. To clarify, suppose Si(t),i = 1,...,N are the prices of N stocks at time t and αi,i = 1,...,N are constants.
A vanilla basket option on this stock basket is simply a vanilla option on U(t). In more detail, on an exercise date t, the payoff of the option is:
K = an exercise price and
α = 1 for a call and -1 for a put.
Such a vanilla basket option is also known as a portfolio option. Note that if N = 2, α1 = 1 and α2 = - 1, the basket option is simply a spread option.
There are many other types of basket options. For example, corresponding to each asset, there can be an exercise price and a vanilla call or put option and the payoff of a basket option can be the maximum of the payoffs of all these single asset options. Basket options can also be path dependent. The popular ones are the Asian basket options, average strike basket options and lookback basket options. Basket options can be quantos. For such baskets, the underlying assets can be assets of different currencies. The value of a basket is treated, without any currency translation, as the value in units of a certain currency, which may be different from the currencies in which the assets are priced.
For European-style basket options, FINCAD provides several sets of functions to value various types of basket options. For Bermudan and American style basket options, FINCAD provides functions to value vanilla and Asian basket (portfolio) options.