American Versus European Styles

As stated before, most option contracts are simply

bought and sold in the open market without a single

share of stock ever changing hands. However, if you wish

to physically trade shares of stock, you must exercise your

option. When can you exercise your option? The answer

to that depends on the

style of option. There are two styles

of options:

American and European. The style of option has nothing to do with

its origin as implied by the names “American” and “European.” Instead, the style

simply tells us when the option may be exercised. American-style options can be

exercised at any time through the third Friday of the expiration month. European

style options, on the other hand, can

only be exercised on the third Friday of the

expiration month. You generally do not get to select which style of option you

want. All equity options (that is, options on stock) are American style and can

be exercised at any time. Most index options are European style. There are a few

indices that offer both such as the OEX (S&P 100 Index), which is American style

and the XEO (letters reversed), which is the European version of the same index.

It may sound like the American-style option has a big advantage over a

European style. After all, for example, if a stock is really flying high it would be

nice to exercise a call option and buy the shares at a cheaper price and immediately

sell the shares to capture a profit. We’re going to find out in Chapter Four that

exercising a call option early for this reason is a big mistake. You will find out that

most of the time you are better off just selling the call option in the open market

rather than exercising it.

This book is written from the perspective of equity options, so we will assume

that all options discussed are American style unless otherwise stated. We only

differentiate the terms “American” and “European” so you will know what it they

mean if you hear them later while continuing to learn about options. The bottom

line is that all equity options are American style, which means the long position

can exercise them at any time during the life of the option even though it is rarely

optimal to do so.

The last day to buy, sell, or exercise your options is the third Friday of the

expiration month.