American Option
An American option, aka an American-style option, is a version of an options contract that allows holders to exercise the option rights at any time before and including the day of expiration. It contrasts with another type of option, called the European option, that only allows execution on the day of expiration.An American-style option allows investors to capture profit as soon as the stock price moves favorably, and to take advantage of dividend announcements as well.
American Option
Definition
An American option is a type of options contract that allows the holder to exercise the option at any time before and including the expiration date. Unlike European options, which can only be exercised on the expiration date, American options provide investors with the flexibility to profit from favorable movements in stock prices and to benefit from dividend announcements.
Origin
The concept of American options originated in the financial markets of the 1970s when options trading began to gain popularity. The establishment of the Chicago Board Options Exchange (CBOE) in 1973 marked the beginning of standardized options trading. The flexibility and convenience of American options quickly made them a popular choice among investors.
Categories and Characteristics
American options are primarily divided into two categories: Call Options and Put Options.
- Call Option: The holder has the right to purchase the underlying asset at a predetermined price at any time before the expiration date.
- Put Option: The holder has the right to sell the underlying asset at a predetermined price at any time before the expiration date.
The main characteristics of American options include:
- Flexibility: The holder can exercise the option at any time, providing more operational space.
- Potential Profit: Investors can exercise the option timely when the stock price moves favorably, locking in profits.
- Dividend Benefit: The holder can exercise the option before a dividend announcement to receive dividend benefits.
Comparison with Similar Concepts
The main difference between American and European options lies in the flexibility of the exercise time. European options can only be exercised on the expiration date, while American options can be exercised at any time before the expiration date. This makes American options more advantageous in highly volatile markets.
Specific Cases
Case 1: Suppose an investor holds an American call option with a strike price of $50, and the current price of the underlying stock is $55. The investor can choose to exercise the option immediately, buying the stock at $50 and selling it at the market price of $55, thus making a profit of $5.
Case 2: An investor holds an American put option with a strike price of $60, and the current price of the underlying stock is $55. The investor can choose to exercise the option immediately, selling the stock at $60 even though the market price is only $55, thus making a profit of $5.
Common Questions
1. Which is better, American or European options?
This depends on the investor's strategy and market conditions. American options offer more flexibility but are usually more expensive.
2. Why are American options more expensive?
Because American options provide the flexibility to exercise at any time before the expiration date, this additional choice increases the value of the option.
