Difference Between European option vs American option
A European option can be defined as a type of call option that can be redeemed only at its expiration or maturity date. A European option is usually traded at a discount as the holder of the same as a single opportunity for exercising it. European option vs American option in this article, the holder of such an option can even choose to sell the option and close his or her position if at all he or she is unwilling to wait for its maturity or expiration date. European options are mainly traded over the counter and are less likely to be found on the major stock exchanges. On the other hand, an American option can be defined as a type of call option that can be redeemed anytime during the period lying between the date of option trading and expiration or maturity date.
The holder of such an option gets to wait for the best price and then he or she can accordingly exercise or redeem the option between the date of option trading or date of purchase and maturity date. In contrast to the European options, American options tend to provide greater flexibility and this is one of the reasons why the latter is widely popular and high in demand too. European options are less risky as compared to the American options since the maturity date is fixed in the case of the former while the same depends on the holder of the option in the case of the latter.
Head to Head Comparison Between European option vs American option(Infographics)
Below are the Top 13 comparison between European option vs American option:
Key Differences Between European option vs American option
The key differences between the European option and American option are as follows:
- European style options are less popular and thus low in demand. On the other hand, American style options are high in popularity and more in demand.
- European style options are less risky as compared to the American style options.
- European style option does not offer purchase and sale of shares whereas the same is allowed in the case of American style options.
- In European style options, a settlement is possible only in cash whereas, in American style options, the settlement is possible only in stock.
- The premium offered is quite low in the case of a European style options as the holder of the option gets to redeem the option only at its expiration date whereas the premium offered is high in the case of an American style options as the holder of the same gets to redeem the option anytime between the date of option trading and its expiration date.
- European style options are mostly traded over the counter whereas American style options are mostly traded over the exchanges.
- Formulation of a hedging strategy is easier in the case of European style options whereas the same is really difficult in the case of American style options.
Comparison of Table Between European option vs American option
Given below are the major difference between European option vs American option:
| Basis of Comparison | European option | American option |
| Low/ High premiums | In the case of European style options, the premium offered is quite low as the holder of the same gets to redeem the option only at its maturity date. | In the case of an American style option, the premium offered is high as the holder of the same gets to redeem the option anytime between the date of option trading and its maturity date. |
| Popularity | European style options are not that popular and this is why these options are less traded. | American style options are very popular and this is why these options are high in demand. |
| Trading | European style options are traded mostly OTC or over the counter. | American style options are traded mostly OTE or over the exchanges. |
| Hedging | It is easier to formulate a hedging strategy in a European style option as the holder of the same can redeem the option at the maturity date which is already known. | It is difficult to formulate a hedging strategy in an American style option as the holder of the same gets to decide as and whenever the option can be redeemed by him or her. |
| Risk factor | As the maturity date is already fixed, the profits or losses can be easily estimated. This is why European style options carry a lower rate of risk. | As the maturity date is decided by the option holder, he or she may choose to redeem the same as and whenever he or she thinks it quite profitable. This is why American style options carry a higher rate of risk. |
| Last trading day | The last trading day in case of European style options is the third Thursday of every month. | The last trading day in the case of American style options is the third Friday of every month. |
| Treatment of tax | The tax treatment in the case of European style options is 60 percent long term capital gains. | The tax treatment in the case of American style options is 100 percent short term capital gains. |
| Cash/ stock settlement | Cash settlement only. | The stock settlement only. |
| Purchase and sell shares | Purchase and sale of shares not allowed. | The purchase and sale of shares are allowed. |
| Exercise right | Only at the date of maturity. | Anytime between the date of purchase or date of option trading and maturity date. |
| Call options | Purchase of stock only on the date specified. | Purchase of stock only on or prior to the date specified. |
| Put options | Sell of stock only on the date specified. | Sell of stock only on or prior to the date specified. |
| Number of dates | Just one date. | Multiple dates until the date of maturity. |
Conclusion
A European style option is not that pricey as compared to American style options. The premium offered in American style options is higher as compared to the options offered in European style options. European style options are usually traded OTC or over the counter, whereas American style options are usually traded OTE or over the exchanges. European options are less risky as the option holder gets to redeem the option only at the date of maturity whereas the American style options are way riskier as the option holder gets to redeem the option anytime between the date of purchase and maturity date.
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This is a guide to European option vs American option. Here we discuss the difference between European option vs American option, along with key differences, infographics, & comparison table. You can also go through our other related articles to learn more–
