When you start trading options, you will encounter two different exercise styles: American and European. Despite their names, these terms have nothing to do with geography. They describe when you can exercise an option. Understanding the difference is important because it affects pricing, risk, and your trading strategy.
The Basic Difference
The fundamental distinction between American and European options is when they can be exercised:
American options: Can be exercised at any time before or on the expiration date.
European options: Can only be exercised at expiration.
American Style Options
American style options give you maximum flexibility. You can exercise them on any trading day up to and including the expiration date.
Where You Find American Options
- Individual stock options: AAPL, TSLA, AMZN, etc.
- ETF options: SPY, QQQ, IWM, XLF
- Most equity options in the US
American Option Example
You buy an AAPL call option expiring in 30 days. At any point during those 30 days, you can:
- Hold the option and wait
- Sell the option in the market
- Exercise the option and receive shares
You have complete flexibility to act when it benefits you.
Early Exercise Considerations
Just because you can exercise early does not mean you should. Early exercise is rarely optimal because:
- You give up any remaining time value
- Selling the option usually yields more than exercising
- Exercising requires more capital (buying shares)
However, early exercise sometimes makes sense:
- Deep ITM calls before dividends: To capture the dividend
- Deep ITM puts with no time value: To earn interest on the cash
- Options with almost no extrinsic value: Selling might not be practical
European Style Options
European style options can only be exercised at expiration. This might seem limiting, but it has some advantages.
Where You Find European Options
- SPX options: S&P 500 index options
- NDX options: NASDAQ 100 index options
- VIX options: Volatility index options
- Most cash-settled index options
European Option Example
You buy an SPX call option expiring in 30 days. During those 30 days, you can:
- Hold the option and wait
- Sell the option in the market
You cannot exercise until expiration day. At expiration, it settles automatically based on the settlement price.
Key Differences Compared
| Feature | American | European |
|---|---|---|
| Exercise timing | Any time | At expiration only |
| Early assignment risk | Yes (if short) | No |
| Premium | Slightly higher | Slightly lower |
| Settlement | Usually physical | Usually cash |
| Common examples | Stock options, SPY | SPX, NDX, VIX |
Pricing Differences
American options are generally worth slightly more than identical European options. The extra value comes from the early exercise flexibility. However, this difference is usually small because early exercise is rarely optimal.
The pricing difference is most noticeable for:
- Deep in-the-money options
- Options on dividend-paying stocks
- Put options in general (due to potential early exercise value)
Early Assignment Risk
If you sell American style options, you face early assignment risk. This means the option buyer could exercise at any time, forcing you to fulfill your obligation unexpectedly.
Early Assignment Example
You sell a covered call on Stock XYZ with a $50 strike. The stock rises to $58 right before the ex-dividend date. The call buyer might exercise early to capture the dividend, and you would have to deliver your shares at $50.
With European options, you never face this risk. You know exactly when settlement will occur.
Why Traders Choose European Style
Despite having less flexibility, many traders prefer European options for certain strategies:
- No early assignment risk: Short positions are more predictable
- Cash settlement: No need to handle shares
- Tax advantages: SPX options have favorable 60/40 tax treatment
- Larger notional value: Better for large portfolios
Settlement Differences
American and European options often have different settlement methods:
American Options (Physical Settlement)
When exercised, actual shares change hands. You either receive or deliver 100 shares per contract.
European Options (Cash Settlement)
When exercised, you receive cash equal to the intrinsic value. No shares change hands.
Settlement Comparison
You have an ITM $4,500 call. At expiration, the underlying settles at $4,550.
- Physical (SPY): You buy 100 shares at $450, worth $455 each
- Cash (SPX): You receive $5,000 cash ($50 x 100 multiplier)
Both yield $5,000 profit, but the mechanics differ.
SPY vs SPX: A Practical Example
Both track the S&P 500, but they have different exercise styles:
- SPY options: American style, physical settlement
- SPX options: European style, cash settlement
Many traders use SPX for selling premium strategies because there is no early assignment risk. Others prefer SPY for the smaller contract size and physical shares.
Which Should You Trade?
Consider these factors when choosing:
Choose American Style When:
- You want flexibility to exercise early
- You might want to take delivery of shares
- You are trading individual stocks
Choose European Style When:
- You want to avoid early assignment risk
- You prefer cash settlement simplicity
- You want potential tax advantages (Section 1256 contracts)
- You are selling premium strategies on indexes
Common Misconceptions
- "American options are traded in America": No, the name refers to exercise style, not location
- "I should always exercise American options early": Rarely optimal; selling usually yields more
- "European options are inferior": They have advantages, especially for sellers
Track All Your Options Positions
Pro Trader Dashboard tracks both American and European style options. See exercise style, settlement type, and key metrics for every position.
Summary
American options can be exercised any time before expiration, while European options can only be exercised at expiration. Most stock options are American style, while index options like SPX are European style. Understanding these differences helps you choose the right options for your strategy and manage risks like early assignment.
Ready to learn more? Check out our guide on options settlement or learn about contract specifications.