Chooser option

A chooser option is a special type of option contract. It gives the purchaser a fixed period of time to decide whether the derivative will be a European call or put option.

In more detail, a chooser option has a specified decision time t₁, where the buyer has to make the decision described above. Finally, at the expiration time t₂ the option expires. If the buyer has chosen that it should be a call option, the payout is max(S − K,0). For the choice of a put option, the payout is max(K − S,0). Here K is the strike price of the option and S is the stock price at expiry.

Replication

For stocks without dividend the chooser option can be replicated using one call option with strike price K and expiration time t₂, and one put option with strike price $K e^{-r(t_2-t_1)}$ and expiration time t₁;^[1].

References

1. ^ Yue-Kuen Kwok, Compound options

Bibliography

• Yue-Kuen Kwok, Compound options (from Derivatives Week and Encyclopedia of Financial Engineering and Risk Management) [1]