European Option

Definition

The term European option refers to an agreement that can be exercised only on a specific day prior to its expiration date.  Call or put options involving stock market indexes are typically European-style options.

Explanation

Also known as a European-style option, a European option is a contract that can be exercised only on a certain day before its expiration date; typically, this occurs at maturity.  Options traded on major market indexes are typically European-style.  Options on commodities may be European or American.  And while American options may trade on exchanges, European options oftentimes trade over-the-counter.

Generally, monthly European options expire on the Friday prior to the third Saturday of the month and are closed for trading on the preceding Thursday.  Since European options do not allow their holders to exercise their rights any time prior to its expiration date, they are considered less "valuable" than American options, which offer this feature.  The two most common European-style options include:

  • European Call Option:  provides the holder with the right, but not the obligation, to purchase the underlying asset at the strike price on the contract's expiration date.
  • American Put Option:  provides the holder with the right, but not the obligation, to sell the underlying asset at the strike price on the contract's expiration date.

Note:  Although European options do not allow the holder to exercise their right to purchase or sell the underlying asset prior to the contract's expiration date, the holder does have the right to close out their position by selling their option.

Related Terms

hedge, hedge ratio, gamma, fungibility, expiration Friday, expiration date, exercise by exception, American option