American vs. European Options
What’s the Difference?
Our previous guide to options trading covers everything you need to know about options trading, the different examples for call and put options and the different kinds of greeks in options trading. This blog is a continuation of our previous guide to explain to you the differences between the American and European style options.
American and European style options are not regionally exclusive options contracts. You can trade them in any part of the world. It is important to understand the difference between these options contracts before trading them.
This blog provides you with the definition for American and European options, their essential terms, their similarities and finally their differences.
Options Styles
American Options
An American option is a contract that gives the right, but not the obligation, to buy or sell a cryptocurrency at a future specified date, and claim such a right at any time before the contract’s expiration date.
European Options
A European option is a contract that gives the right, but not the obligation, to buy or sell a cryptocurrency in the future, by claiming such a right only on the expiration date, as specified by the contract.
What does exercise mean?
An exercise is a process where the buyer, or holder of the option, claims the rights to the contract. A call option gives the holder the right to buy, while the put option provides the holder with the right to sell the underlying cryptocurrency at a specified price called the strike or exercise price. The options’ expiration date serves as the threshold for when the holder can exercise the contract.
Due to the greater flexibility they provide, most of the options traded today are American ones. European options are less risky but have shown a growing interest in the market.
Before we visit the differences between American and European options, here are some of the similarities between both options styles.
Similarities
Both the American and European options have a set strike price and an expiration date that is fixed at the time of purchase. No changes can be made to the expiration date once the options contracts have been purchased.
Another similarity between both styles of options is that they can only be exercised once, before their expiration dates.
Differences
The key difference between American and European style options are given below -
- American Options can be redeemed at any point between the date of purchase of the option and the expiry date. European Options can only be exercised on the date of expiry of the option.
- The premium offered for European style options is quite low as compared to American style options. This is particularly due to the greater flexibility that American options have of exercising the contract anytime before the expiration date. European options can only be exercised at their maturity date.
- It is seen that European style options are not as popular as the American ones.
- It is easier to formulate a hedging strategy in a European style option as the holder of these contracts can redeem the option only at maturity. American options holders get to strategies.
- Since American style options can be redeemed to maximise profits, they also carry a higher rate of risk, unlike European options. These options have a fixed expiry date and therefore carry a lower rate of risk.
Conclusion
While we have discussed American and European options, there is a third but less common option called Bermuda Options. These options are widely considered an intermediary between American and European options in that they allow exercising on specific days prior to expiration. For example, if an option contract expires in July, Bermudan options may allow the investor to exercise the option every Monday in August. Thus Bermuda options are flexible to a certain extent but are not as flexible as American options. Bermudan options are still considered more exotic options, despite their rising popularity.
About Oddz
Oddz is a trustless on-chain derivatives trading platform that expedites the execution of call and put options contracts, conditional trades, and futures. It allows the creation, maintenance, execution, and settlement of trustless option contracts, conditional tokens agreements, and futures contracts in a fast, secure, and flexible manner.
It employs the synergies of Ethereum, Binance Smart Chain, Polkadot, Polygon, Elrond Network and Chromia to unleash the potential decentralized derivatives market. It focuses on building solutions that can propel the DeFi ecosystem by simplifying derivatives trading and enhancing the user experience.
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