Exotic Options: Multiasset Options

Question 1

What are basket options?

Answer 1

For basket options the payoff depends on the average return of a basket of assets.
Payoff_{Basket call} = Max[Σⁿ_i=1 ω_iR_i - K; 0] x N
Where R_i is the return of asset i, ω_i is its weight in the basket, K is the strike (often set to zero)

Since the result of he Max function would be ea percentage number the result is multiplied by N (notional) that defines the size of the contract

Question 2

What is the relationship between an option on a basket and a basket of options?

Answer 2

An option on a basket is worth (and costs) less than a basket of option.

Question 3

What is the relationship between the correlation of the underlyings in the basket of of a basket call and its value?

Answer 3

Higher correlation would imply higher volatility on the portfolio and a higher option value.
The buyer is bullish on correlation/long correlation
The seller is bearish on correlation/short correlation.

Question 4

What is the relationship between the number of underlying assets and the value of a basket call?

Answer 4

The more assets there are in a basket the more diversified the portfolio is, the les volatile and the less it is worth

Question 5

What is a best (worst) option?

Answer 5

In best options the payoff is a function of the best performing asset within a basket.
In worst options, a function of the worst performing

Question 6

What is the relationship between the number assets in a basket of a best call option and the value of the option?

Answer 6

If there are more assets, a best call option would be worth more

Question 7

What is the relationship between the correlation of assets in a basket of a best call option and the value of the option?

Answer 7

If correlation increases the option would be worth less: lower (or ideally negative) correlation would make more likely that at least one index can perform well.
The buyer is bearish on correlation/short correlation
The seller is bullish on correlation/long correlation