Burst Basket and Uses

What is a Burst Basket?

A burst basket refers to a transaction that executes the sale or purchase of a group of stocks, known as a basket. A basket is essentially an entire portfolio of stocks from different sectors. This portfolio of stocks is aggregated into a single trading unit, the basket. Baskets typically contain at least five stocks, but often 15 or more. They are commonly used in index tracking and currency portfolio management. Baskets are traded on both the NYSE and the CBOE for institutions and index arbitrageurs.

Understanding the Burst Basket

The term "burst basket" is used in reference to the actual execution of a trade of a basket of stocks, particularly in conjunction with execution used in program trading. Program trading refers to trading done through the use of mathematical algorithms to buy or sell securities.

Burst Baskets Versus Tracking Funds

Index mutual funds and exchange traded funds (ETFs) are examples of tracking funds, which are managed to closely track the performance of a stated index. For example, the SPDR S&P 500 ETF (SPY) is built to track the performance of the S&P 500 index.

One downside of an index mutual fund or ETF is a lack of flexibility or customization. When you purchase these instruments, you are not able to make any changes to the holdings within them. You get the stocks and sometimes derivatives that the instrument holds, and cannot pick and choose what you personally would change about the holdings.

With a basket trade, you have some to tweak the basket of stocks to favor one company or industry over another. When it comes to the question of flexibility to customize a portfolio's holdings, baskets have the advantage. However, mutual funds and ETFs may have advantages in terms of expense and tax efficiency for retail investors.

Example of How Baskets Compare to Funds

For retail investors, purchasing a pre-made basket — like an ETF or mutual fund — is a more economical choice. Buying 500 (actually 505, subject to change) stocks to get a portfolio representative of the S&P 500 would incur significant costs, and even buying one share of each company may cost more than the investor has to invest. Amazon.com Inc. (AMZN) is included in the S&P 500, and as of Dec. 5, 2020 is priced at $3,162, and Alphabet Inc. Class C (GOOG) is priced at $1,827. Not all investors could afford one share of each of these companies, let alone attempting to buy the other 503.

Compare this to an ETF, where an investor can buy a single share of the SPDR S&P 500 ETF, for example, and own a piece of all the companies in the S&P 500 index. As of December 5, 2020 SPY was trading near $366. So for $366 per share an investor owns a tracked basket of stocks.

An institution with low trading costs, large amounts of capital to deploy, and algorithmic or automated trading capabilities, may create its own basket orders, buying or selling dozens or even hundreds of different stocks all at the same time. This allows the firm to fine-tune what they want to buy and sell, instead of relying on pre-packaged baskets.