What is an American Option?

The American option is an investment opportunity that is somewhat similar to the European-style option, but is characterized by one important difference. With American options, it is possible to exercise the option at any point prior to the expiry date. This is different from the European style of stock option, which can only be exercised on a specified date.

It is important to remember that the American option has the same potential for cash flows as their international counterparts featuring the same underlying, strike price, and expiry date. The key to maximizing the amount of return on American stock options is to watch the dividends closely. If there are no dividends paid on the underlier from the date of acquisition to the expiry date, then it is a pretty safe bet that the option value of the option will be more than the intrinsic value. For this reason, many investors who choose to deal with an American option will hold the option all the way to the expiry date.

At the same time, it may be a good idea to exercise an American option if dividend payments are made on the underlier at some point. Generally, the best time for this strategy is just after the payments on the dividends are issued. Exercising the option at this point has an excellent chance of earning a better return than holding on until the expiry date is reached, once dividend payments have been issued.

One advantage to an American option is that the investor can choose to exercise the option if there is a need to unload the security quickly. This may occur due to financial reversals, or a desire to pull out of this particular investment for some reason. Because the American option is designed with the ability to exercise the option at any time, there are no penalties to waive or any complicated process to follow. While the best return on an American takes place when there are non dividend payments issued and the option is held all the way through to expiry, there is a good chance of making at least some profit even if the option is exercised early.