This article introduces Chooser Options, and provides a pricing spreadsheet. Chooser options give the investor the privilege of choosing whether the option is a put or a call at some predetermined date. Generally, the investor chooses the more valuable option.
Chooser options enable the investor to hedge against possible future events. Their purchase generally increases before events like elections or major company announcements, with the time to choose taking place, a few days afterwards
Chooser options are path dependent. This means that the payoff at maturity varies with the history of the asset price as well as the spot price.
Simple choosers have the same strike price and time to maturity for the call and the put. Their price is defined by the following equations, derived by Rubinstein (1991).
- pricesc is the option price
- S is the spot price of the asset
- b is the cost of carry
- X is the strike price
- σ is the asset volatility
- T is the time to maturity
- Tc is the time to choose
- N is the cumulative normal distribution
Complex choosers, however, allow the strike price and time to maturity for the call and the put to differ. The governing equations are more complex, and must be solved iteratively.
Chooser options are also called “As You Like It” options”, and their flexibility means they are more expensive than their vanilla counterparts. The price of the option increases as the time to choose increases, as illustrated by the following graph.