Let not the name deceive you. The naive may conclude that ‘American options’ trade in America and the ‘European’ in Europe. However, that’s not the case. The name implies the type of option rather than the geography!!
American options allow the holder of the option to exercise the option at any point before expiry. On the other hand European options can be exercised only at option expiry. Thus the two kinds of options differ because an American option allows the user and early exercise. Most of the options that you see in the market today are American options.
Value wise, at expiration, an American and a European option will have the same value. However, prior to expiration these 2 options are conceptually different. Consider 2 options, one American and one European, having the same underlying, the same exercise price and the same time until expiration. The American option provides the owner, all the rights and privileges the owner of the European option possesses. In addition, the holder of an American option can execute the option before expiration. Hence, at any point of time before expiration, an American option is at least as valuable as a similar European option.
Refer to the book ‘Understanding Options’ by ‘Robert W.Kolb’ for more options!!
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