Chooser Options: Flexibility in Derivatives Trading

Derivatives traders must be aware of different types of futures and options in the market. When it comes to options, most of us know about the call and put options. Besides these options, investors can trade chooser options to make a profit. Continue reading to understand more about it.

What is a Chooser Option?

You already know that an option allows the holder to buy/sell the underlying asset at a strike price on a future date. An option holder can exercise or ignore the contract on the expiration date. A call option will give you the right to purchase the underlying asset, whereas a put option allows you to sell the underlying asset on the expiration date. You can proceed to purchase a call or a put option individually. Investors can also purchase a chooser option, which can be changed into a call or a put option.

It offers much-needed flexibility to investors. One can change it into a call or a put option before the expiration date. One must take their decision before the expiration date. The flexibility offered cannot be observed with traditional options and futures. However, these are costlier than traditional options due to increased flexibility. The expiration date for both put and call in a chooser option remains the same. 

How Does it Work?

Chooser options do not follow any other mechanism than that of calls and puts options . It combines the features of both puts and calls to offer more flexibility to investors. When you change an option into a call, it works similarly to a traditional call. The same can be said if it is changed into a put before the expiration date. However, one must know that it usually has the same expiration date and strike price. Whether you change it into a call or a put, the strike price and the expiration date remain the same. These  This option pricing formula is not the same as that of traditional options. Since the flexibility factor is also considered, it becomes costlier than traditional options.

Example

Derivatives trading can become more flexible with the help of chooser options. Let us take a chooser option example to understand the working. Let us say you purchase it with stocks of a company ‘XYZ’ as the underlying asset. The strike price for stocks of XYZ is INR 100, while the expiration date is six months from now. Let us say the market price of XYZ stocks is INR 120 just before the expiration date. In such a case, you can change it into a call to purchase stocks at a lower rate. When the market price is more than the strike price, you can change it into a put option. It will allow you to sell stocks of XYZ at a higher price and earn returns.

Advantages

Now that you understand what is a chooser option, let us discuss its advantages, which are as follows:

• Option trading becomes more flexible. You can change it into a call or a put before the expiration date based on the current market conditions.

• It helps investors with risk management. You are open to more risks by investing in only a call or a put option. On the other hand, you can switch between a call and a put to eliminate risks.

• You can switch between a call and a put before the expiration date in a chooser option. It provides investors with more time to study market conditions and make informed decisions.

• It can help investors implement different trading strategies. One can switch between call and put options to achieve their investment goals.

Disadvantages

Even though chooser options are beneficial, there are a few risks. Here are the associated cons:

• Since it offers increased flexibility, they are costlier than traditional options. Investors will have to pay more premiums to acquire these options.

• It can be confusing for new investors. They might fail to make the right call between a call and a put. Wrong calls can lead to losses or missed opportunities for options traders.

• These This pricing formula is not the same as traditional options. Additional factors are considered to calculate the premium for these options. The flexibility factor is the most essential when calculating the price of a chooser option.

• There might be liquidity issues in some markets. There might not be ample buyers and sellers.

In a Nutshell

Chooser options are flexible contracts for investors. One can change it into a call or a put before the expiration date. Since it offers flexibility, they usually have a high premium. However, one must be aware of liquidity risks associated with these options in some markets. Search for these options on your trading platform now!