American Option
Quick Definition
An option contract that can be exercised at any time before or on the expiration date, providing maximum flexibility to the holder.
What Is American Option?
An American option gives the holder the right to exercise the contract at any point during its life, up to and including the expiration date. This contrasts with European options, which can only be exercised at expiration. Most equity options traded on U.S. exchanges are American-style. The added flexibility of early exercise means American options are generally worth at least as much as otherwise identical European options. Early exercise is most commonly advantageous for deep in-the-money call options on stocks about to pay dividends, or for deep in-the-money put options where the time value is minimal compared to the interest that could be earned on the proceeds.
American Option Example
- 1You hold an American call option on XYZ stock with a $50 strike. The stock jumps to $80 before a large dividend — you can exercise early to capture the dividend
- 2An American put option on a stock trading at $5 with a $50 strike can be exercised immediately to lock in $45 of intrinsic value rather than waiting
Related Terms
European Option
An option contract that can only be exercised at expiration, not before, typically found in index options and OTC markets.
Bermudan Option
An option that can be exercised on specific predetermined dates before expiration, falling between American and European exercise styles.
Early Exercise
The act of exercising an American-style option before its expiration date, typically done only when specific conditions make it financially advantageous.
Call Option
A contract giving the holder the right, but not the obligation, to buy an underlying asset at a specified price within a specified time period.
Put Option
A contract giving the holder the right, but not the obligation, to sell an underlying asset at a specified price within a specified time period.
Strike Price
The predetermined price at which the holder of an option can buy (call) or sell (put) the underlying asset upon exercise.
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