Chooser option

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

In more detail, a chooser option has a specified decision time $t_{1}$ , where the buyer 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 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 $t_{2}$ , and one put option with strike price $Ke^{-r(t_{2}-t_{1})}$ and expiration time $t_{1}$ ;.[1]

References

Yue-Kuen Kwok, Compound options

Bibliography

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

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[1] Yue-Kuen Kwok, Compound options