AMERICAN STYLE OPTION Meaning and
Definition
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An American style option is a type of financial derivative contract that grants the holder the right, but not the obligation, to exercise the option at any time before its expiration date. Unlike its counterpart, a European style option, which can only be exercised on the expiration date, American style options offer greater flexibility to the holder by allowing early exercise.
Essentially, an American style option gives the owner the opportunity to buy or sell the underlying asset at a predetermined price, known as the strike or exercise price, at any point until the option's expiration. This type of option is commonly used in various financial markets, including stocks, commodities, and bonds.
The main advantage of an American style option lies in its flexibility. Since the holder has the freedom to exercise the option whenever it is deemed advantageous, it allows for more strategic decision-making in response to changing market conditions. This flexibility may be particularly valuable in situations where the price of the underlying asset is approaching or exceeding the strike price.
However, it's important to note that the flexibility of American style options typically comes at a higher cost compared to European style options. This higher cost arises because of the added benefit of being able to exercise the option prior to expiration. Traders and investors must carefully assess the potential benefits and costs of American style options relative to their specific investment goals and risk tolerance.
