1. Options Basics: Introduction
  2. Options Basics: Call and Put Options
  3. Options Basics: Why Use Options?
  4. Options Basics: How Options Work
  5. Options Basics: Types of Options
  6. Options Basics: How to Read An Options Table
  7. Options Basics: Options Spreads
  8. Options Basics: Options Risks
  9. Options Basics: Conclusion

American and European Options

Now that we’ve talked about the differences between calls and puts, let’s explore some other differences of categorizing options contracts. American options can be exercised at any time between the date of purchase and the expiration date. The example of Cory's Tequila Co. shows the use of an American option. Most exchange-traded options are American. European options are different from American options in that they can only be exercised at the end of their lives on their expiration date. The distinction between American and European options has nothing to do with geography, only with early exercise. Many options on stock indexes are of the European type. Because the right to exercise early has some value, an American option typically carries a higher premium than an otherwise identical European option. This is because the early exercise feature is desirable and commands a premium.

Options Expiration & Liquidity

Options can also be categorized by their duration. Short-term options are those that expire generally within a year. Long-term options with expirations greater than a year are classified as long-term equity anticipation securities, or LEAPs. LEAPS are identical to regular options, they just have longer durations. Although they aren’t available on all stocks, LEAPS are available on most widely held issues. You should know that LEAPS can be less liquid than shorter term options, so they are not ideal for short-term trading.

Options can also be distinguished by when their expiration date falls. Traditionally, listed options have expirations on the third Friday of the month. However due to increased demand, sets of options now expire weekly on each Friday, at the end of the month, or even on a daily basis. Index and ETF options also sometimes offer quarterly expiries.

Options Exchanges

Options traded on exchanges are called listed options. In the U.S., there are a number of exchanges, both physical and electronic, where options are traded. For U.S. stocks, there are 15 options exchanges on the last count. Options can also be traded directly between counterparties with the use of an exchange or an ISDA agreement; these are known as over-the-counter (OTC) options. Often, financial institutions will use OTC options to tailor specific outcome events that are not available among listed options.

Market makers exist in order to provide liquidity to options markets. They are required to “make” a two-sided market in an option if asked to quote. Market makers, using theoretical pricing models, can take advantage of arbitrage by exploiting theoretical mis-pricings between the options’ perceived value and its market price.

The simple calls and puts we've discussed are sometimes referred to as plain vanilla options. Even though the subject of options can be difficult to understand at first, these plain vanilla options are as easy as it gets.

Because options are so versatile, there are many other types and variations of options. When ordinary listed or OTC options won’t do, there are exotic options. They are exotic because there might be a variation on the payoff profiles from the plain vanilla options.  Or they can become totally different products all together with "optionality" embedded in them. For example, binary options have a simple payoff structure that is determined if the payoff event happens regardless of the degree. Other types of exotic options include knock-out, knock-in, barrier optionslookback optionsAsian options and Bermudan options. Again, exotic options are typically for professional derivatives traders.

Options Basics: How to Read An Options Table
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