Quote There is rebalacning of the 2 assets at 50/50 at each time step and there is no dividend. is this how the option was priced initially ?

daveangel, The option is priced under a blackscholes framework using a combined volatiltiy number from the 2 assets (i.e. square root of variance of the basket). So I guess I have assumed the 50/50 split to be constant across the time horizon. seahawk

have u tried running the simulation with the same vols and correlation of 1 ? In which case you should have the same results as before.How different are the vols of the 2 assets ?

Yes, I did and when the two assets have the same vol with correlation of one. Hedging the two assets individually vs hedging the basket index will give me the same result. Then I tried shifting the correlation to 0.2, hedging the basket index still works but hedging the two assets individually creates a lot of noise. I have tried to change the time step to 0.01 but it still yields unstable results in some scenarios, there will be really large losses. Do you want me to send you the file?

Very sorry to bump up this thread, But i have a question based on "FX Basket Options Valuation with Smile" by Uwe Wystup,hopefully, a guru can shed some light.Firstly;the author gives a closed form analytical formula for the premium of a european basket call option, based on some assumptions.for my scenario, I chose a 2 component basket -USD/MYR and SGD/MYR [FX] and used historical values from BB. weights == static 0.49/0.51I have managed to match the basket premium to the sum of the individual call options under perfect correlation (ie corrMatrix =1 for all entries), with optimal strikes for each individual call option( ie optimal lambda), as mentioned in the paper.I used historical vols with a rolling window of 18 days. My maturity is 18 days. I also applied a term structure to the foreign/domestic interest rates.With a daily hedging regimen(only deltas were considered), I have managed to match the hedging cost with the basket premium. the deltas were calculated via finite difference,from the basketPremium function[Eqn 16] as per paper. the p&L of my hedging portfolio is also very small relative to the notional, with about 1.4% standard deviation.I chose maturity of 18 days(arbitrary)also I chose the basket strike, K=2.7 How did i get this value? by trial and error, until i got the above-mentioned results.My question is, is there a way to place upper/lower bounds on the basket strike, instead of a trial and error approach? i dont feel confident with "trial and error"..if the basket strike is out of a certain range( ie say if i choose basketStrike<2.6 or >2.8), no solution for the optimal strikes since abs(lambda)>1..lambda lies within the inverse cumulative normal distribution...(Eqn 44)thanks in advance for any help