American option
Also written American-style option · American style option
An option whose holder may exercise it at any time on or before expiry. All exchange-traded index and stock options in India are European style instead — exercisable only on expiry.
In plain language
An option gives its buyer a right. The style of the option decides when that right can be used.
- American option — the owner can exercise at any time on or before the expiry date.
- European option — the owner can exercise only on the expiry date.
The names have nothing to do with where the options trade. An option listed in Mumbai could be American; one listed in Chicago could be European.
The single most examinable fact about American options in this paper is a negative one: in India, all index and stock options are European style options. Chapter 4 says it twice, and Chapter 7 says it again for both index and stock options when it explains final settlement.
How it works
For the buyer, an American option carries everything a European option does plus flexibility: the right can be used on any day, not just the last one.
For the writer, that flexibility is a burden. The workbook warns that when you are short an option you can be assigned an exercised option any time during the life of the contract (in case of American options) — "all option writers should be aware that assignment is a distinct possibility." With a European option, assignment can only arrive at expiry.
In Indian market data, option type codes still distinguish the two styles (Chapter 6, section 6.7):
| Code | Meaning |
|---|---|
| CE | Call European |
| PE | Put European |
| CA | Call American |
| PA | Put American |
In pricing, style matters too. The workbook notes that the factors affecting premium apply to both American and European options, but that the put-call parity principle is only applicable to European options.
A worked example
Illustrative. The stock, prices and dates are hypothetical, and the contrast is theoretical — Indian exchange-traded stock options are European.
Priya buys a call on XYZ Ltd, strike Rs 500, premium Rs 20, expiring on the last Tuesday of the month. Lot size 1,000 shares.
Premium paid = 20 × 1,000 = Rs 20,000
In the second week, XYZ jumps to Rs 560 on news.
If the call were American, Priya could exercise immediately:
Exercise value = (560 − 500) × 1,000 = Rs 60,000
Net of premium = 60,000 − 20,000 = Rs 40,000
Because the call is European, she cannot exercise that day. Her choices are to wait for expiry and exercise if the call is still in the money, or to sell the call in the market — squaring off with a closing sale of the same series. The market price of the call will reflect its intrinsic value of Rs 60 per share plus any remaining time value, so selling is how an Indian option holder captures an early move.
The writer's side is the mirror image: had it been American, the writer could have been assigned mid-month without warning.
Why NISM asks about it
Chapter 4, section 4.1 (option terminology), defines American and European options and states that all Indian index and stock options are European. Section 4.5 carries the warning about early assignment for American option writers. Chapter 7, section 7.4, repeats that index and stock options are European-style when describing final exercise settlement. A sample question at the end of Chapter 4 tests exactly this distinction.
Common exam traps
- Indian exchange-traded index and stock options are European. Any option stating they are American, or "both", is wrong.
- American means on or before expiry, not "after expiry" and not "only before expiry".
- Early assignment is a writer's risk in American options, not in European ones.
- Put-call parity applies only to European options.
- A European option holder is not locked in until expiry — he can still sell the option in the market. He just cannot exercise it early.
- The name describes exercise style, not geography.
Where this is taught
- Series IV · Chapter 4: Exchange Traded Interest Rate Optionsintroduced here
- Series XVI · Chapter 4: Commodity Optionsintroduced here
- Series V-D · Chapter 21: Exchange Traded Interest Rate Optionsintroduced here
- Series VIII · Chapter 4: Introduction to Optionsintroduced here
Related terms
- Intrinsic valueWhat an asset is actually worth — the present value of the cash it will generate over its remaining life, as against whatever price the market is quoting today.
- Break-even pointThe level of the underlying at which a position makes neither profit nor loss — for a bought call, strike plus premium; for a bought put, strike minus premium.
- MoneynessWhether exercising an option right now would give the buyer a positive, zero or negative cash flow — classifying it as in the money, at the money or out of the money.
- Time valueThe part of an option premium that is not intrinsic value — what the buyer pays for the possibility that the underlying moves further in his favour before expiry. It falls to zero on expiry day.
- Option premiumThe price an option buyer pays the seller for the right the contract carries — non-refundable, and made up of intrinsic value plus time value.
- Option writerThe party who sells an option: receives the premium upfront and takes on the obligation to sell (call) or buy (put) the underlying if the buyer exercises. Gain is capped at the premium.
- Bermudan optionAn option that can be exercised only on specific dates named in the contract, usually near expiry — more flexible than a European option, less flexible than an American one.
- ExercisePutting an option's right into effect: a call holder buys the underlying at the strike, a put holder sells at the strike. In cash settled IRD options the holder simply receives the difference.
- Binomial pricing modelAn option pricing model that maps the underlying's possible prices as a tree of up and down moves at equally spaced time steps — accurate and flexible because it is iterative, but slow to compute.
- AssignmentThe allocation of exercised options to one or more option sellers — the moment the writer's obligation becomes a real cash outflow, decided by the exchange and not by the writer.
- European optionAn option that can be exercised only on its expiry date. Indian equity options are European — coded CE for calls and PE for puts — unlike American options, exercisable any time up to expiry.