What is an 'American Option'

An American option is an option that can be exercised anytime during its life. American options allow option holders to exercise the option at any time prior to and including its maturity date, thus increasing the value of the option to the holder relative to European options, which can only be exercised at maturity. The majority of exchange-traded options are American.

BREAKING DOWN 'American Option'

American options allow the holder to buy or sell a specified underlying asset, on or before a predetermined expiration date. Since investors have the freedom to exercise their American options at any point during the life of the contract, they are more valuable than European options, which can only be exercised at maturity. The last day to exercise a weekly American option is normally on the Friday of the week in which the option contract expires. Conversely, the last day to exercise a monthly American option is normally the third Friday of the month. Note that the name of this option style has nothing to do with the geographic location.

American Call Option

Consider this example: If an investor purchased a call option on Apple Inc. in March, expiring in December of the current year, the investor would have the right to exercise the call option at any time up until its expiration date. If the call option on Apple Inc. had been a European option, the investor would only be able exercise the option at the expiry date in December. If, hypothetically, that share price became most optimal for exercise in August, the investor would still have to wait until December to exercise the call option, when it could be out-of-the-money and virtually worthless.

Assume the investor exercised the call option on Apple prior to the expiration date, the investor would be long 100 shares of Apple at the specified strike price. Conversely, if the investor waited until the expiration date and Apple's stock price closed at least one cent above the strike price, the investor would be automatically exercised and long 100 shares.

American Put Option

Contrary to an American call option, the holder of an American put option has the right to exercise the option at any point in time until its expiration date. Assume an investor purchased a Facebook Inc. July put option in January. The investor has the right to exercise the put option on or before the option's expiration date. If the investor decides to exercise the put option, the investor would be short 100 shares of Facebook at the predetermined strike price.

RELATED TERMS
  1. Early Exercise

    Early exercise is the process of buying or selling shares under ...
  2. European Option

    An option that can only be exercised at the end of its life, ...
  3. Bermuda Option

    A type of exotic option that can be exercised only on predetermined ...
  4. Exercise Backdating

    A practice where option holders fraudulently claim to have exercised ...
  5. In The Money

    1. For a call option, when the option's strike price is below ...
  6. Option

    A financial derivative that represents a contract sold by one ...
Related Articles
  1. Trading

    4 Reasons To Hold Onto An Option

    There are times when an investor shouldn't exercise an option. Find out when to hold and when to fold.
  2. Trading

    Three Ways to Profit Using Call Options

    A brief overview of how to provide from using call options in your portfolio.
  3. Trading

    Getting acquainted with options trading

    Learn about trading stock options, including some basic options trading terminology.
  4. Trading

    Options Hazards That Can Bruise Your Portfolio

    Learn the top three risks and how they can affect you on either side of an options trade.
  5. Trading

    Understanding How Dividends Affect Option Prices

    Learn how the distribution of dividends on stocks impacts the price of call and put options, and understand how the ex-dividend date affects options.
  6. Trading

    The Basics of Covered Calls

    Learn how this options strategy can lower the risk of stock or futures contract ownership while increasing potential profits.
  7. Investing

    How To Buy Oil Options

    Crude oil options are widely traded energy derivatives, but with a twist. They're options on futures, offering the investor certain advantages over oil futures.
RELATED FAQS
  1. How do I change my strike price once the trade has been placed already?

    Learn how the strike prices for call and put options work, and understand how different types of options can be exercised ... Read Answer >>
  2. How is a put option exercised?

    Learn the process, and what happens, when you exercise a put option. Also read about alternatives to exercising an option. Read Answer >>
  3. Can an option be exercised on the expiration date?

    The use of options has increased dramatically over the years as a way to profit from or hedge against the volatile movements ... Read Answer >>
Hot Definitions
  1. Net Present Value - NPV

    Net Present Value (NPV) is the difference between the present value of cash inflows and the present value of cash outflows ...
  2. Price-Earnings Ratio - P/E Ratio

    The Price-to-Earnings Ratio or P/E ratio is a ratio for valuing a company that measures its current share price relative ...
  3. Internal Rate of Return - IRR

    Internal Rate of Return (IRR) is a metric used in capital budgeting to estimate the profitability of potential investments.
  4. Limit Order

    An order placed with a brokerage to buy or sell a set number of shares at a specified price or better.
  5. Current Ratio

    The current ratio is a liquidity ratio that measures a company's ability to pay short-term and long-term obligations.
  6. Return on Investment (ROI)

    Return on Investment (ROI) is a performance measure used to evaluate the efficiency of an investment or compare the efficiency ...
Trading Center