In finance, a chooser option is a special type of

option contract An option contract, or simply option, is defined as "a promise which meets the requirements for the formation of a contract and limits the promisor's power to revoke an offer". Option contracts are common in professional sports. An option contrac ...

. It gives the purchaser a fixed period to decide whether the

derivative In mathematics, the derivative of a function of a real variable measures the sensitivity to change of the function value (output value) with respect to a change in its argument (input value). Derivatives are a fundamental tool of calculus. ...

will be a

Europe Europe is a large peninsula conventionally considered a continent in its own right because of its great physical size and the weight of its history and traditions. Europe is also considered a subcontinent of Eurasia and it is located entirel ...

call Call or Calls may refer to: Arts, entertainment, and media Games * Call, a type of betting in poker * Call, in the game of contract bridge, a bid, pass, double, or redouble in the bidding stage Music and dance * Call (band), from Lahore, Paki ...

or put option. In more detail, a chooser option has a specified decision time

t_1

, where the

buyer Procurement is the method of discovering and agreeing to terms and purchasing goods, services, or other works from an external source, often with the use of a tendering or competitive bidding process. When a government agency buys goods or serv ...

has to make the decision described above. Finally, at the expiration time

t_2

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 In finance, the strike price (or exercise price) of an option is a fixed price at which the owner of the option can buy (in the case of a call), or sell (in the case of a put), the underlying security or commodity. The strike price may be set ...

of the option and

S

is the stock price at expiry.

Replication

For stocks without

dividend A dividend is a distribution of profits by a corporation to its shareholders. When a corporation earns a profit or surplus, it is able to pay a portion of the profit as a dividend to shareholders. Any amount not distributed is taken to be re-i ...

, the chooser option can be replicated using one call option with

K

and expiration time

t_2

, and one put option with

K e^

and expiration time

t_1

;.Yue-Kuen Kwok, Compound options

References

Bibliography

* Yue-Kuen Kwok,

Compound option A compound option or split-fee option is an option on an option. The exercise payoff of a compound option involves the value of another option. A compound option then has two expiration dates and two strike prices. Usually, compounded options are ...

s (from Derivatives Week and Encyclopedia of Financial Engineering and Risk Management

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