Options can be divided into two broad categories: American-style options and European-style options.
These two types of options are more similar than they are different, but it is important to know the features that distinguish both styles from each other. This article will explain all of the similarities and differences of American and European options.
A key difference between the two option types is that American options can be exercised at any time before the expiration date, or on the expiration date. Whereas, European options can only be exercised on the expiration date.
Most stock options are traded American-style while most index options are traded European-style.
For example, assume an investor buys an American-style option for The Walt Disney Co. (DIS) today and it expires in a month. He can exercise it today, tomorrow, or any other trading day until the option’s expiration.
Now let’s assume an investor buys a European-style option for the S&P 500 Index (SPX) today and it expires in a month. The investor cannot exercise the option today or tomorrow. He can only exercise his option on the expiration date.
Since American-style options can be exercised at any time until the expiration date, these options tend to be more expensive than European-style options. This is because the seller of an American-style option is assuming more risk than the seller of a European-style option.
American and European options are very similar, but the differences between the two types of options are the things that should be noted from this article. Just remember, American options can be exercised any time before, or on the date of expiration. European options can only be exercised on the expiration date. Because of this, American options tend to have higher prices than European options.