Sunday, October 20th, 2019

European Style Stock Options

 

In trading European style options, an options contract can only be exercised on expiration of the options contract. When trading exchange-traded options in the USA, standardized stock options contracts typically consist of one hundred shares of the stock. Contract lengths are standardized. Although European style stock options can only be exercised at expiration, unlike American style options, one can exit a European style stock options contract at any time during the contract period. Thus a stock options trader can execute the opposite to trade and pocket his profits or limit his losses without waiting until the end of the contract period. The difference in execution of options trades between European style stock options and American style stock options can be significant for stock investors.

Buying Calls with European Style Stock Options

A call gives the purchaser the right to purchase the underlying stock at a set price as defined by the contract. This price is called the strike price. In the case of European style stock options this can only happen at the end of the contract term. With an American style options contract the purchaser can execute the contract at the most opportune time during the contract period. An issue arises here for an investor who expects to be able to use a call option to take advantage of an expected rise in a stock price. If the stock price moves up rapidly the investor may choose to execute the contract and buy the stock. He wants to keep the stock but is concerned about a reversal. As such he can buy puts on the stock to protect his gains while still holding the stock. This is not possible in trading European style stock options as one cannot execute the contract and take the stock prior to expiration. The only way to guarantee a profit when the options contract price rises is to exit the contract and take a profit but not hold the stock. This may be limiting for a number of stock options trading strategies.

Buying Puts with European Style Stock Options

A put gives the purchaser the right to sell the underlying stock at the strike price no matter how far it might fall. In the case of trading European style stock options, one can only sell at expiration. An investor who has seen his stock rise dramatically over several months may choose to purchase puts on the stock. By doing so he can sell at the current price no matter how far the price might fall. In trading American style stock options a trader can execute the contract and sell stock if the price falls markedly. He does not need to wait until the expiration of the contract. On the other hand in trading European style stock options the only way to deal with a dramatic loss is to sell the options contract for a profit and use the profit to compensate for losses with the stock itself. Stock option trading with European style options can be profitable but investors and traders must also understand the limitations.

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