lystn

Hey everyone, welcome back. This is Kirk here again at Option Alpha. Today, I want to talk about on the daily call, the simple difference between American-style and European-style options contracts. It’s a very subtle difference, but like I said in the title of this show today, a very simple difference between these two styles of contracts. Now, most people will end up trading… If you trade options, most of you or the vast majority of the trading that you do will be on an American-style option contract and very few of you… Or if you even do most trading even as you start to scale, very few of the contracts that are out there are what’s called European-style option contracts. Now, the difference between the two really comes down to exercise at assignment, when an option contract can be exercised or assigned. American-style options which again is the vast majority of most ETFs, most stocks… Vast majority of contracts are what’s called American-style. Those contracts can be exercised or assigned any time up until expiration. If you have a contract that's 30 days from expiration, somebody could decide if they wanted to… Not that it’s likely to happen necessarily, but the choice is there. Somebody could decide to exercise or assign that contract with 25 days left until expiration, with five days or two days or seven days. Basically any point between the time that you enter into the contract and expiration, you can be assigned, you can exercise, you have that choice. On the other hand, European-style options limit that exercise or assignment choice to expiration, so one predefined point in the future. That means that if you get into a European-style option contract, then the risk of assignment or exercise is not present until expiration, meaning somebody can’t choose to arbitrarily assign that contract early or exercise that contract early. If they wanted to do that, they have to wait until the expiration date in the future. Now, where you see this most often is in index style options. The SPX, the RUT, the NDX, etcetera are all European-style contracts mainly because they’re cash-settled. There’s no need to have the ability to let them exercise early because you would get nothing. They’re all cash-settled index options, meaning they settle to just the value of the contract related to the underlying price. You don't get shares of the SaP 500. There’s no shares to get. You don’t get shares of the Russell 2000. There’s nothing there to get. Most of those styles of contracts are European-style because at expiration, we don't really need to do anything ahead of time with shares or contracts. That's why most regular options, I guess American-style options on ETFs and stocks have the ability to exercise early because there are underlying shares. You can buy the stock or short the stock. You can buy the ETF or short the ETF. There’s dividends that are involved which might cause early assignment expiration. That's why the fundamental reason why there's a difference between these two contracts. But again, unless you’re trading in index or something along those lines, most of the stuff that you’ll be doing and most of the trading we do at Option Alpha since we do a lot of ETFs and stocks is American-style. As you start to transition and start to scale up, if you do transition to the higher valued index options, then those are going to be what’s called European-style. Hopefully this helps out just understanding this difference and this nuance. As always, if you guys have any questions, let us know. Until next time, happy trading!