What is a Chooser Option?

Malcolm Tatum

Also known as an AC-DC option or an either/or option, a chooser option is an investment option where the investor has the ability to exercise that option as a put or call at specific points during the life of the option contract. One of the benefits of this approach is that investors are positioned to respond to prevailing market conditions in ways that would not be possible otherwise. Typically, this type of option does cost a little more to structure, but the flexibility can pave the way for generating additional returns or minimizing losses.

Man climbing a rope
Man climbing a rope

Commonly employed since the early 1990’s, a chooser option is different from what is known as a standard vanilla option. With a standard option, the investor does not have a choice of going with a put or call at some point during the life of the option. Instead, the choice is made at the time the option is secured. While this approach works very well in many situations, it may not be the most productive method, depending on the type of investment involved, and any market conditions or anticipated movements that the investor believes could come to pass in the near future.

In many ways, a chooser option is similar to another investment strategy that is known as a straddle. Both approaches make it possible to put or call the option at specified times, with the straddle being structured to execute a put and a call simultaneously, then following up with a second order to achieve the desired effect. This means the straddle may be somewhat more complicated to manage than a chooser option, and may in fact be a cheaper approach, since only one order is necessary to execute the desired action.

The dual nature of a chooser option has also led to the strategy being referred to as a hermaphrodite option in some circles. This is indicative of the ability of the investor to move in either direction that he or she believes is the most prudent at the time that something must be done with the option. An option of this type is sometimes employed with derivatives and is also utilized to great effect with futures contracts. As with all investment strategies, comparing the benefits and potential drawbacks of going with a chooser option to other possible strategies, both in terms of outcome and up-front costs, is essential before actually committing to this type of arrangement.

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