American Style Options
Definition of an American Option:
An American option or American Style Call is an option for the right to buy a stock or an index at a certain price at or prior to its expiration date. Notice the phrase "prior to a certain date." This "American Style Call" differs from the "European Style Call" in that the European Style Call can only be exercised ON the expiration date.
In other words, the difference between a European style call option and an American style call option is that European style call options can be exercised ONLY on the expiration date while the American style call options can be exercised at any time PRIOR to their expiration date.
As far as I know, all equity calls and puts traded in the US are American Style, where as most index options traded in the U.S. are European style. The index options also happen to be cash-settled since you can't actually buy 100 shares of an index.
What does this European Style Call or Put mean for the trader? It means that the you are concerned ONLY with the price of the stock or index at its expiration. European style options tend to be cheaper than American style options because if a stock price spikes prior to expiration, an American style option trader can capitalize on that increase in value, whereas the European style trader has to hope the price spike holds until expiration.
When to buy an American Option
You really don't have a choice in specifying that you want an American Style or a European Style call or put. You just have to take the style that is currently being offered on the stock or index that you want. But in general, the same call and put rules apply. If you think a stock price or index value is going to go up, then you should buy a call.
Example of a American Call Option
If you bought a 100 shares of Apple Computer (AAPL) at $335 and you are afraid the price might drop below $300, you can buy an AAPL Put Option with a strike price of $300. That way if the price drops to $275 you will be able to exercise your option and sell your stock for $300. Please note that you don't "HAVE TO" sell your AAPL shares at $300! If the price in the market is $350 then of course you can sell your shares in the market at $350. That is why they are called options--it is your choice as to whether or not you exercise it. It is not an obligation.
Important Tip: In the U.S., most equity and index calls and puts expire on the 3rd Friday of the month. Also, note that in the U.S. most contracts allow you to exercise your options at any time prior to the expiration date. In contrast, most European options only allow you to exercise them on the expiration date.
Here are the top 10 option concepts you should understand before making your first real trade: