American vs. European Style Options
In this training lesson we'll cover the major differences between American and European style options. Pay close attention to this video because most traders get confused as to what they can (or can't do) with each style. Remember that we are specifically talking about the ability to exercise an options contract. Trading either style does not affect your ability to close or trade options prior to expiration should you need to get out of a position.
In this video, we’re going to talk about American style versus European style options. And specifically, this relates just to how they are exercised and your ability to exercise them as you go through the market.
First, we’re going to talk about American style options. With American style options, you can exercise these any time you want before expiration. For example: If you own a call option and there's 15 days to expiration, you can still exercise that option and buy the stock at the strike price.
Now, what we’re talking about here is actually physically exercising your option and converting that one option into 100 shares of underlying stock. This is different than if you wanted to actually just get rid of your position and sell it back to the market.
You could still make a profit that way. But if you want to exercise the option, you want to actually own the underlying shares of stock, then this is what you would do with an American style option.
Again, you can do this any time before expiration and up to expiration. Now, this is different than European style options. With European style, you can only exercise options at expiration.
In our last example, if there was 15 days to go and you wanted to exercise your option and buy the actual stock, you couldn’t do that. You would have to wait until the actual expiration date.
Now, this doesn’t mean you can’t get out of the contract. This just means you can’t convert it to underlying shares. You can easily sell this contract back to the market and get whatever value is left in it and still create a profit.
Now, most index and Forex options particularly on the RUT, SPX, NDX and the USD/EUR are European style meaning that they’re typically cash settled and they’re settled only on expiration.
You can’t actually physically go in and buy shares of the SPX because it’s just an index. These are typically less common and most of the options that you’re going to trade are going to be American style, meaning you can exercise them or convert them any time in the future.
As always, with this ability, you have more value. As with anything, the more options you have, the more valuable it is. Now, because an owner of an American style option has the right to exercise it at any time before it expires, they have more flexibility which gives the contract more value all other things being equal.
Think about it this way. What if the price of a stock you had an option on jumped 50% and you still had to wait 30 days to buy the underlying stock? If you wanted to buy that stock right now with an American style option, you could go out to the market and buy that stock.
Now, this doesn’t mean you can’t just sell the option back to the market and make your money. But if you wanted to own the stock, then you would have to wait with a European style option.
Wouldn’t this be less favorable as an option buyer? You have less choices, that means that there’s less things you can do, less ouch you have, less ways to manage risk. Overall, European style options are going to be just a little bit cheaper than the traditional American style.
As always, on Option Alpha for our members, we have a great option expiration calendar that we have for about four years into the future. As soon as the exchanges publish their expiration calendar, then we get those.
And what's great about it is that it has these holiday days on here, it has the option stop trading days and then also has the options expiration day.
Now, this is different because some people will typically think that since the options stop trading on that Friday that they expire that same day, but it’s different.
Options actually stop trading on the third Friday of every month and they actually expire that following Saturday, so you have a little time to actually make some decisions with your broker.
It’s always important to know when option expiration is and when some of the bigger trading holidays are going forward. As always, I hope you guys really enjoy this video and thanks for watching.
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