Saturday, August 24th, 2019

American Style Stock Options

 

Trading American style stock options is not a matter of Americans being patriotic. It is a matter of adding value to the options that you buy. The extra value of American style stock options over European style stock options is that one can execute American style stock options at any time during the contract period. In both American and European style options trading, one purchases or sells puts or calls, employs fundamental analysis of the underlying stock, and assesses market sentiment with technical trading tools. American style stock options are available on markets outside of the United States as well. There are, in fact, a number of types of options styles:

  • American: can be exercised on any trading day until expiration
  • Asian: payment is based on average underlying price over a stated period of time
  • Barrier: the price of the underlying must rise or fall past a given barrier before exercise is allowed
  • Binary: payment is all of nothing depending on the terms of the contract
  • Bermudan: can be exercised only on specific dates up until expiration
  • European: can only be exercised on expiration
  • Exotic: generally refers to options based on complex financial structures
  • Vanilla: simply means that the option is not exotic

Trading American Style Stock Options

Many beginning traders limit themselves to purchasing either calls or puts on stocks. The trader pays for the right to buy in the case of a call or sell in the case of a put. The worst that a trader can do in either case is lose the price of the contract. The best that a trader can do is to execute or exit the contract at the optimum time. In both American style options trading and European style options trading a trader can simply sell the contact for its current value. This value obviously rises with price of the underlying in a call contract and rises with the fall of the underlying in a put contract. But, what if the trader wants to take possession the stock? This happens with investors who see an opportunity to get into a stock a good price. The investor can execute the contract in an American style contract and then purchase puts on the stock in order to protect his position. This feature is not available in European style options. Likewise in a put contract an investor may have a stock that has risen rapidly. He may want to protect himself against a fall in stock price. Using American style stock options he can get out of the stock when it falls and still sell at the original price, called the strike price, and not have to wait with his money tied up until expiration of the options contract. The fact that European style options limit execution of options trades can be a major factor in which style to trade.

Which Is the Way to Go?

The most important factors in options trading are the same as in trading stocks directly. Know or learn the fundamentals and follow the market with technical indicators. Stick with practical options trading tactics. If the inability to execute an options contract midway through the contract period is important, avoid European style and stick with American style stock options. Otherwise, simply exit your position at the most profitable moment by executing the opposite trade.

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