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What is an American Option?

An American option is a call or puts option that can be exercised both before and after its expiration date. Options typically include maturity dates when holders can exercise them; European and American options are prime examples. Unlike European options, which may only be exercised at maturity dates, American options can be exercised both before and beyond the maturity date. 

In most options, the option price is decided by the underlying asset's price movement, which can be upward or downward. It is permissible in the American Option for a holder to exercise an option before its maturity if he or she believes it is the wisest decision.

American Style Option - Explained

An American option is a derivative contract that can be redeemed or exercised at any moment throughout the Option's life or at the Option's maturity date. This means that the option holder or investors can exercise the Option at any moment before or after the expiration date. American options are typically valued more than their European counterparts, which can only be exercised at maturity. 

Investors must pay a premium if they exercise their options early. People frequently confuse American and European options with geographic locations; nevertheless, it is vital to note that the names here have nothing to do with geographic locations.

Types of American Options

  1. American Call Option

An investor can exercise the American Call Option at any time up until the maturity date. This means that the investor must choose the most advantageous moment to exercise the Option. 

  1. American Put Option

A put option in the United States is the polar opposite of a call option. Holders of any option, however, have the choice to exercise it before or on the expiration date. An investor who acquires a put option does not have to wait until the Option expires to exercise it, as is the case with a European option.

Benefits of American Style Options

Here are some of the major benefits of investing in American Style options:

  • The possibility to exercise the contract at any moment before the expiration date is the primary advantage of American options.
  • The opportunity to exercise the contract before the ex-dividend date, allowing the option holder to own the stocks and receive dividends for the following period.
  • It makes it easier to maximize profits and stimulates higher market participation.

 

When to Buy American Style Options?

An American-style option gives you a lot more options. However, your options may be limited in this regard, as the type of Option available may be determined by the exchange and the asset. You may get American call options for equities in India, for example. 

For index and currency options, however, American options are not available. As a result - you would have no choice but to accept whatever is on offer in this scenario.

Difference Between an American Option and a European Option

The basic distinction between the two types of choices is when they can be used. European options can only be exercised at their expiration date, at a single moment in time, but American options can be exercised at any time before their expiration date.

It's worth noting that, with a few exceptions, American-style options are practically never exercised before expiration in actuality, so the distinction isn't significant. When the stock price rises after you purchase an option, most people will just sell the option contract to someone else rather than exercising it.

The table below points out all of the major differences between an American and a European option:

American Option

European Options

You could exercise it at any time before the expiration date.

They are exercisable only on the expiration date.

It has more flexibility, and they are usually worth more and command a higher premium.

They are much less flexible, which means they are usually worthless and command a lower premium than American options.

They are typically mostly US stock options.

Some US index options are European styles.

They are usually traded on exchanges.

They are usually traded over the counter.

 

What is an American Option? - FAQs

Do we have any American options in India?

Stock options in Indian markets are now in the American model, meaning they can be exercised at any time throughout the contract's term.

Is the Nifty option an American or European Option?

At the NSE, all index options are European Options. Futures and options transactions are cash paid at the NSE.

What is the American Option pricing?

A numerical technique is required to appropriately assess an American option. Pricing of American options includes 2 concerns mainly i.e. finding an optimal strategy for when to use the option and pricing the option accordingly.

What are the distinctions between the European and American options?

The holder of a European Option has the right to exercise the Option only at a pre-determined future date and price. The American Option offers the option holder the right to exercise the Option at the pre-agreed price at any time before the date of expiration.

What are the American options?

The usual closing price or the last trade before the market shuts on the third Friday is the settlement price for the underlying asset (stock, ETF, or index) with American-style options.

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