Definition
The term European option refers to an agreement that can be exercised only on a specific day prior to its expiration date. Call or put options involving stock market indexes are typically European-style options.
Explanation
Also known as a European-style option, a European option is a contract that can be exercised only on a certain day before its expiration date; typically, this occurs at maturity. Options traded on major market indexes are typically European-style. Options on commodities may be European or American. And while American options may trade on exchanges, European options oftentimes trade over-the-counter.
Generally, monthly European options expire on the Friday prior to the third Saturday of the month and are closed for trading on the preceding Thursday. Since European options do not allow their holders to exercise their rights any time prior to its expiration date, they are considered less "valuable" than American options, which offer this feature. The two most common European-style options include:
European Call Option: provides the holder with the right, but not the obligation, to purchase the underlying asset at the strike price on the contract's expiration date.
American Put Option: provides the holder with the right, but not the obligation, to sell the underlying asset at the strike price on the contract's expiration date.
Note: Although European options do not allow the holder to exercise their right to purchase or sell the underlying asset prior to the contract's expiration date, the holder does have the right to close out their position by selling their option.
Related Terms
The term hedge refers to a strategy that establishes a new position in an asset to protect the profitability of an existing position. While a hedge can be used to control risk, and lower a potential loss, that same hedge will also reduce potential gains.
Moneyzine EditorJanuary 19th, 2024
The term hedge ratio refers to a mathematical formula that compares the value of a hedge to the value of the position in an asset. Calculating and tracking hedge ratios allows investors to understand and control their exposure to the price volatility of various assets.Moneyzine EditorSeptember 20th, 2023
The term gamma refers to the rate of change in delta for a one point change in the price of an underlying asset. An option's gamma is typically expressed in terms of a percentage change in delta for a one-point change in the underlying asset's price.Moneyzine EditorJanuary 19th, 2024
The term fungibility refers to the interchangeability of assets due to standardization. Trading and exchange of an asset is simplified if it possesses the characteristic of fungibility.Moneyzine EditorNovember 6th, 2024
The term expiration Friday refers to the last business day an option can be sold, purchased, or exercised before it expires. Expiration Friday occurs each quarter, and is characterized by higher than normal price volatility and trading volumes.Moneyzine EditorNovember 6th, 2024
The term expiration date refers to the final day the holder of an option contract can exercise their right under the agreement. After the expiration date, the seller of an option can no longer be assigned.Moneyzine EditorNovember 6th, 2024
The term exercise by exception refers to the automatic exercise of in-the-money options at expiration. The Options Clearing Corporation (OCC) institutes exercise by exception unless explicit instructions prohibit exercising the option.Moneyzine EditorNovember 6th, 2024
The term American option refers to an agreement that can be exercised at any time prior to, and including, its expiration date. Call or put options involving equities or common stock are typically American-style options.Moneyzine EditorNovember 6th, 2024
