Business, Legal & Accounting Glossary
A chooser option (or preference option) is a path-dependent option for which the purchaser pays an up-front premium and has the choice of having the derivative be a vanilla put or call on a given underlier. She has a fixed period of time to make that choice. There is usually a single strike and expiration date that apply to both the put and call alternatives.
A typical structure might have the time to choose equal to half the entire time to expiration of the instrument. The chooser feature becomes increasingly valuable with longer choice periods. In the limiting case, as the chooser period approaches the entire time to expiration, the instrument becomes equivalent to a straddle. Not surprisingly, choosers are purchased as inexpensive alternatives to straddles; they are volatility plays.
Rubenstein (1991) provides analytic formulas for pricing chooser options, including structures in which the put and call alternatives have different strikes and expiration dates. The formulas are limited by the fact that they assume a single implied volatility for the entire life of the instrument. More accurate pricing requires separate volatility assumptions for the choice period and the remaining life of the instrument following the choice.
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This glossary post was last updated: 16th April, 2020 | 26 Views.