European Style Options
Difference Between American and European Options
- American Style Calls and Puts
- What are Call Options?
- What is a Put?
- Option Expiration Date
- Exercising Options
Definition of a European Call Option:
A European call option is an option for the right to buy a stock or an index at a certain price ON a certain date. Notice the phrase "ON a certain date." This "European style call option" differs from the "American style call option" that can be exercised at any point "BY a certain date."
Eurpoean vs American Option Examples
In other words, the difference between European calls options and American calls options 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.
Most stock or equity options in the U.S. are American Style, whereas most index options traded in the U.S. are European style. Since you can't actually "exercise an index option" and buy the index, index options are cash-settled. Cash settled means that your broker simply deposits the "in the money" amount at expiration.
What does this European style option 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 spikes prior to expiration, an American style call option trader can capitalize on that increase in value, whereas the European style call trader has to hope the price spike holds until expiration.
When to buy a European Call Option:
If you think a stock price or index is going to go up, then you should buy a call option. Unfortunately, you don't get to choose if you want to buy a European style option or an American style option--that decision is made by the exchange that the option trades on. Most index options in the U.S are European style as you can see from the chart below:
Example of a European Call Option:
If you bought a S&P500 Index option, as you can see from the chart above, it would be a European style option. That means that you can only exercise the option on the expiration date. Of course it is still an option, which means that you have the right but not the obligation to exercise it.
Obviously, if you have a call option and the Index closes below the strike price on the expiration date then you would not exercise it and that option would just expire worthless. Likewise, if you have a put option on the Index and the Index closes above the strike price on the expiration date then you would not exercise it and that option would just expire worthless.
Notice in the chart above that the S&P500 Index (SPX)is European style while the S&P100 (OEX) is American style.
Important Tip: In the U.S., most equity and index option contracts expire on the 3rd Friday of the month. Also, note that in the U.S. most contracts allow you to exercise your option at any time prior to the expiration date. In contrast, most European options only allow you to exercise the option on the expiration date!
Here are the top 10 option concepts you should understand before making your first real trade: