American Option

What is an American option?

An American option (American-style option) is an options contract that can be exercised at any time up to and including its expiration date. This contrasts with a European option, which can only be exercised on the expiration date. The flexibility to exercise early can be valuable for capturing favorable price moves or securing dividend rights.

Important: the terms “American” and “European” describe exercise style only, not geographic location.

How American options work

• An option gives the holder the right—but not the obligation—to buy (call) or sell (put) the underlying asset at a specified strike price.
• For American options, that right may be exercised any time during the contract’s life.
• Early exercise adds value compared with European-style options, so American options generally trade at higher premiums.
• Typical exercise deadlines:
• Weekly options: last exercise day is usually the Friday of the expiration week.
• Monthly options: last exercise day is typically the third Friday of the expiration month.
• Most exchange-traded single-stock options are American; many index options are European.

American calls and puts

• Long call: the holder can demand delivery of the underlying security at the strike price on any day before expiration. The holder may choose not to exercise and can instead sell the option in the market.
• Long put: the holder can require the seller to take delivery of the underlying asset at the strike price at any time before expiration. Exercising a put converts the option into immediate proceeds (the strike price), which can be reinvested.

Considerations:
– Exercising a put yields immediate cash that can be put to work (opportunity cost/benefit).
– Exercising can forfeit future option upside and, for calls, may create obligations (e.g., paying for and holding shares).
– Exercising before an ex-dividend date can be advantageous for call holders who want to capture an upcoming dividend.

When to exercise early

Early exercise is uncommon because selling the option often preserves time value while realizing gains. Typical reasons to exercise early include:

• Deep-in-the-money options: when intrinsic value far exceeds time value (commonly > $5–$10 in-the-money, depending on stock price).
• Capture dividends: exercising a call before the ex-dividend date to become a shareholder and receive the dividend.
• Put exercise for cash needs: when the immediate strike proceeds are more valuable than holding the option.
• Costs and interest rates: if carrying the underlying is cheaper than the time value lost by exercising (cost of carry).

Traders often compare:
– The option’s market premium (what you could sell it for) versus
– The immediate value from exercising (intrinsic value plus any dividends or reinvestment benefit), net of transaction costs.

Advantages and disadvantages

Pros
– Flexibility to exercise any time up to expiration.
– Ability to capture favorable moves immediately.
– Can exercise before ex-dividend date to receive dividends.
– Immediate proceeds from exercised puts can be reinvested.

Cons
– Higher premiums than otherwise equivalent European options.
– Early exercise may forfeit remaining time value and potential additional upside.
– Not all option types (e.g., many index options) are American-style.

Examples

Example 1 — Call exercised early
– Buy one American call on AAPL with strike $100, premium $5 (one contract = 100 shares → $500 premium).
– Stock rises to $150.
– Exercise: buy 100 shares at $100, sell at $150 → $50 × 100 = $5,000 gross profit.
– Net profit ≈ $5,000 − $500 premium − transaction costs.

Example 2 — Put exercised
– Buy one American put on META with strike $150, premium $3 ($300 total).
– Stock falls to $90.
– Exercise: effectively sell 100 shares at $150 while market price is $90 → $60 × 100 = $6,000 gross.
– Net profit ≈ $6,000 − $300 premium − transaction costs.
– In practice many brokers settle the net cash difference rather than delivering shares.

Key takeaways

• American options allow exercise at any time before expiration, offering flexibility and the potential to capture dividends or immediate profits.
• That flexibility usually commands a higher premium than European options.
• Early exercise is optimal in certain situations (deep-in-the-money positions, ex-dividend timing, or specific cash/reinvestment needs) but often traders prefer to sell the option to retain remaining time value.