What Is a Chameleon Opportunity?
A chameleon option has the ability to change its structure should predetermined terms of the contract be met, such as a specified increase or diminution in the price of the underlying asset. A chameleon option gives an investor greater flexibility in that they can trade a chameleon choice instead of trading multiple vanilla options to attain the same result.
Key Takeaways
- A chameleon option has the ability to variation its structure should predetermined terms of the contract be met, such as a specified increase or decrease in the price of the underlying asset.
- Chameleon privileges are traded over the counter (OTC) and are therefore customizable based on what the buyer and seller agree on.
- The advantage of the chameleon selection is its flexibility on terms, although it typically demands a higher premium because of this highly customizable nature.
Alliance the Chameleon Option
Chameleon options are traded over the counter (OTC) and are therefore customizable based on what the buyer and seller grant on. In simplest terms, a chameleon option could be both a call or put option, depending on which side of the strike expenditure the underlying asset is on. If the underlying asset is priced above the strike price it could be a call option, and if the underlying asset’s cost is below the strike price, then it could be a put option. If a trader expected a large move in a stock, but was unsure of the conduct, instead of buying both a call and put they could purchase a chameleon option structured like this.
The advantageously of the chameleon option is its flexibility. The parties can agree to their own strike price, expiration date, contract size, whether it’s a hail or put, and at which intervals any of these variables change.
The disadvantages of a chameleon option include a higher premium than a vanilla alternative, primarily because the chameleon offers a greater chance of the option finishing
Example of a Chameleon Option
Chameleon selections are highly customizable, so the following is just one possible way it could be structured.
Assume a trader wants to buy an at the money call privilege that expires in one month. The underlying stock is trading at $45, so the strike price on the chameleon option is also $45.
Due to a crucial news event coming out in the stock the buyer of the option also wants some downside protection. If the stock wrangles below $40 they want the call turned into a put option.
The chameleon option has given the trader essentially two elections in one. They have a call option if the price of the underlying rises, and they have a put option if the underlying falls secondary to $40.
Assuming a $45 strike vanilla option, that expires in one month, is trading for $1, and the $40 put is trading at $0.08, then the quotation of the chameleon will likely be around $1.08, and possibly slightly less since both parties save on doings fees and the seller may wish to induce the buyer to trade the chameleon instead of simply buying a call and put if it is cheaper to do so.