Basket Option

A basket option is a derivative contract whose underlying is a portfolio — or basket — of multiple assets, such as a group of stocks, currencies, or commodities, rather than a single asset. The payoff is based on the aggregate performance of the basket. For example, an asset manager holding positions in five large-cap Indian stocks may purchase a basket put option to hedge the entire portfolio with a single contract, rather than buying individual put options on each stock. Basket options are cost-efficient because the diversification within the basket naturally reduces its volatility relative to individual assets — and lower volatility means lower option premium. They are primarily OTC instruments used by portfolio managers and institutional hedgers in India.