What is a Chooser Option
A chooser option is an option contract that allows the holder to decide whether it is a call or put prior to the expiration date. Chooser options usually have the same exercise price and expiration date regardless of what decision the holder ultimately makes. Because they don't specify that the movement in the underlying asset be positive or negative, chooser options provide investors a great deal of flexibility when evaluating volatile issues.
BREAKING DOWN Chooser Option
Chooser options are a type of exotic option. These options are generally traded on alternative exchanges without the support of regulatory regimes common to plain vanilla options. As such, they can have higher risks of counterparty default.
Chooser Option Considerations
Chooser options offer the holder the flexibility to choose between a put or a call. These options are typically constructed as a European option with a single expiration date and strike price. The holder has the right to exercise the option only on the expiration date.
A chooser option can be a very attractive instrument when an underlying security reports a high level of volatility or when there is uncertainty around a highly followed corporate development. For example, one might be wise to select a chooser option on a biotech company awaiting the Food and Drug Administration’s reaction to its latest wonder drug or any company facing litigation.
Payoffs for chooser options generally follow the same basic methodology used in analyzing a plain vanilla call or put option. The difference is that the investor has the option to choose the specified payoff they desire at expiration based on whether the call or put position is more profitable.
If a security is trading above its strike price at expiration then the call option exercise is generally the most profitable. If the holder chooses to exercise the option as a call option on the underlying security then the payoff would be: maximum of the (spot price - strike price). In this scenario the holder benefits from buying the security at a lower price than it is selling for in the market.
If a security is trading below its strike price at expiration then the put option exercise would generally be the most profitable. If the holder chooses to exercise their option as a put option on the underlying security then the payoff would be: maximum of the (strike price – spot price). In this scenario the holder benefits from selling the underlying security at a higher price then it is trading for in the open market.