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Definition: Chooser Option
Options are financial derivate instruments that let the buyer bet on the volatility of price movement of the underlying. They give the buyer the right to buy or sell an underlying at a specified price at a specified date, whereas the seller has the obligation to cater to the buyer when the option is exercised.
A chooser option is a special type of option that lets the buyer to decide on whether to buy or sell after a certain period of buying the option, i.e. the buyer need to have a call/put (buy/sell) decision in mind while buying the option. Such an arrangement is useful when the buyer is sure about a movement in price, but is unsure of the direction of the same.
Upon purchase of a chooser option, the buyer is given a chooser date until which he/she can remain undecided on whether to go call/put on the option. On the chooser date, the buyer will have to take a decision on call/put based on the spot price. This gives the buyer sufficient time to predict the direction of price movement.
Date at which buyer buys chooser option – to
Chooser Date – t1
Date at which option expires – t2
Usually, closer the chooser date is to the expiry date, more is the premium on the option as the buyer gets considerable time to make up his/her mind on the option and can do so with more certainty.
Usually, price of a chooser option at expiry (t2)
= Max (S-X, 0)
if the decision taken on choose date is “call” (buyer of call makes a profit when spot price, S, is greater than strike price, X, i.e. when he/she gets to buy at a price lower than spot price)
= Max (X-S, 0)
if the decision taken on choose date is “put” (buyer of put makes a profit when strike price, X, is greater than spot price, S, i.e. when he/she gets to sell at a price higher than spot price).