American vs European Options

Options come in two main exercise styles. An American option can be exercised at any time up to and including its expiration date. A European option can be exercised only at expiration. The names refer to the style, not where the option trades: plenty of American style options trade in Europe and vice versa. The difference affects pricing, assignment risk and the strategies that make sense.

The key differences#

A third style, Bermudan, allows exercise on specific dates before expiry. It is mostly used in over the counter interest rate products.

Where each style is used#

• US equity and ETF options (for example on Apple or SPY) are American style and physically settled.
• Major cash settled index options such as SPX and NDX are European style.
• Options on futures vary: many are American style, though European versions exist.
• Over the counter options between institutions can be either, as negotiated.

Why the right to exercise early usually is not used#

Early exercise throws away the option's remaining time value. It is usually better to sell the option, which captures both intrinsic and extrinsic value.

When early exercise can make sense#

• Calls just before an ex dividend date, when the dividend exceeds the call's remaining time value. Exercising lets the holder own the shares and receive the dividend.
• Deep in the money puts when interest rates are high: exercising early lets the holder receive the strike price in cash sooner and earn interest.

These cases mean American options can be worth slightly more than identical European ones. See Early Exercise.

Assignment risk for sellers#

If you sell an American option, you can be assigned at any time before expiry. This matters for:

• Covered calls near ex dividend dates, where calls may be assigned early.
• Spreads, where early assignment of the short leg can leave an unexpected stock position until you act.
• Margin, since an assignment can create a large stock position overnight.

See Exercise and Assignment.

Pricing differences#

European options can be priced with closed form formulas such as Black-Scholes Model (or Black 76 for futures). American options generally need numerical methods, such as binomial trees or finite difference methods, to account for the chance of early exercise. See Binomial and Trinomial Trees and American Option Pricing.

For American calls on assets with no dividends, early exercise is never optimal, so their value equals the European price.

Which should you trade?#

• Prefer European style if you sell options and want to avoid early assignment, for example selling SPX index options rather than SPY ETF options. Tax treatment can also differ: in the US, broad based index options are typically taxed under Section 1256 rules, which can be favourable. Check with a tax professional.
• American style is unavoidable for single stock options and gives buyers extra flexibility.

Common mistakes#

• Exercising American options early and losing time value.
• Forgetting dividend dates when short calls.
• Assuming all index products are European style: index ETFs such as SPY have American style options.

Frequently asked questions#

What is the difference between American and European options?#

American options can be exercised any time before expiration; European options can only be exercised at expiration.

Are American options more valuable than European options?#

They are worth at least as much and sometimes more, because the right to exercise early has value in some situations.

Are SPX options American or European?#

SPX index options are European style and cash settled, while options on the SPY ETF are American style and physically settled.

Next, split an option's price into its parts in Intrinsic and Extrinsic Value.