An American option is an option contract where investors can use their option rights until the maturity date. As soon as the stock price starts to increase, an American-style option can be used to earn a profit.
American options will define the period of time that the option holder will exercise their option contract rights. Options holders are able buy or sell based on the underlying asset, the expiry date, and the strike prices.
How Do American Options Work?
Before an ex-dividend date, American options can be exercised, enabling investors to buy shares and earn a dividend payout. American-style options are more beneficial than European options. This is because investors have the right to exercise their options at any time during the contract’s duration.
What Is an American Option Used for?
Dividends cannot be accepted by option holders. Stockholders are eligible for dividend payments up until the ex-dividend date. The ex-dividend day is when stockholders are able to collect dividends for the following year. Exercising these options before the ex-dividend date allows the holder to own the securities and be eligible for the next dividend payout.
Why Are American Options Important?
American Options are important because they grant the holder the right to use the option anytime the asset is the most lucrative. The value of a call option increases as the stock price rises, and so does the fee.
Types of American Options
There are two types of American options. These are put and call options that can be used by investors to improve their returns when they’re option trading.
American Put Options
American put options can be executed at any time leading to the expiry date. This grants the holder the right to force the buyer to take ownership of the set underlying asset if the price falls below the strike price stated.
American Call Options
A call option grants the option holder the right to claim delivery of the underlying security within the duration of the contract.
Benefits & Disadvantages of American Options
There are many benefits and disadvantages of American options that investors need to understand before option trading.
Benefits of American Options
- American options can be exercised at any point in time before the set expiration date.
- American options give the holder the right to execute the contract until the ex-dividend date. This requires the owners of the option to own the securities while being liable for next year’s dividend payment.
Disadvantages of American Options
- If the option holder chooses to execute the option contract before the end date, they’ll miss out on a higher appreciation.
- Compared to a European option, an American options are costly. This is because these options charge for a higher price.
Factors Affecting American Options
These types of options are affected by several factors. Let’s review what they are and how they impact the option.
The current selling price of an option deal is known as the option premium. The elements of the premium of underlying assets would include its implied vitality, time value, and intrinsic value.
Derivatives are financial instruments that are based on underlying assets. An underlying asset should be used to describe the entity in an option contract that gives the contract its worth. Knowing the value of an underlying asset allows traders to identify suitable trades to make to maximize their potential returns.
A strike price is the fixed price at which, when it is executed, a derivative contract may be purchased or sold. The strike price is very important when determining the value of an option. When a contract is first written, strike prices are established. It informs the investor of the price at which the underlying asset should get to in order for the option to be in the money.
The maturity date is the date on which a fixed income instrument’s principal must be returned to the lender. The maturity date is the period by which a creditor must completely repay the set loan.
American Options vs European Options
American options can be exercised at any time before the expiration date and European options can be exercised only at the set expiration date. European options are generally exchanged over the counter (OTC), whereas American options are traded on the stock market. For a European option, the holder may only exercise the option at the predetermined expiration date which must be agreed upon by each party involved.
Getting Help Trading American Options
An American option is an option contract where investors can use their option rights up until any time leading to the maturity date. American options grant the option holder the right to use the option anytime the asset or stock is financially beneficial for the option holder. Usually American options will be exchanged on the stock market and European options will be traded over-the-counter.
Financial advisors can help you manage your money and engage trading options. They will execute trades for their clients and provide them with helpful financial advice. Also they can help you with portfolio management so you can strive for long-term financial stability. You should consult a financial advisor today to help you make excellent financial decisions and start option trading.