what is a european option 
a european option is a version of an options contract that limits execution to its expiration date in other words if the underlying security such as a stock has moved in price an investor would not be able to exercise the option early and take delivery of or sell the shares instead the call or put action will only take place on the date of option maturity another version of the options contract is the american option which can be exercised any time up to and including the date of expiration the names of these two versions should not be confused with the geographic location as the name only signifies the right of execution understanding a european optioneuropean options define the timeframe when holders of an options contract may exercise their contract rights the rights for the option holder include buying the underlying asset or selling the underlying asset at the specified contract price the strike price with european options the holder may only exercise their rights on the day of expiration as with other versions of options contracts european options come at an upfront cost the premium it is important to note that investors usually don t have a choice of buying either the american or the european option specific stocks or funds might only be offered in one version or the other and not in both most indexes use european options because it reduces the amount of accounting needed by the brokerage many brokers use the black scholes model bsm to value european options european index options halt trading at business close thursday before the third friday of the expiration month this lapse in trading allows the brokers the ability to price the individual assets of the underlying index due to this process the settlement price of the option can often come as a surprise stocks or other securities may make drastic moves between the thursday close and market opening friday also it may take hours after the market opens friday for the definite settlement price to publish european options normally trade over the counter otc while american options usually trade on standardized exchanges types of european optionsa european call option gives the owner the right to acquire the underlying security at expiry for an investor to profit from a call option the stock s price at expiry has to be trading high enough above the strike price to cover the cost of the option premium a european put option allows the holder to sell the underlying security at expiry for an investor to profit from a put option the stock s price at expiry has to be trading far enough below the strike price to cover the cost of the option premium closing a european option earlytypically exercising an option means initializing the rights of the option so that a trade is executed at the strike price however many investors don t like to wait for a european option to expire instead investors can sell the option contract back to the market before its expiration option prices change based on the movement and volatility of the underlying asset and the time until expiration as a stock price rises and falls the value signified by the premium of the option increases and decreases investors can unwind their option position early if the current option premium is higher than the premium they initially paid in this case the investor would receive the net difference between the two premiums closing the option position before expiration means the trader realizes any gains or losses on the contract itself an existing call option could be sold early if the stock has risen significantly while a put option could be sold if the stock s price has fallen closing the european option early depends on the prevailing market conditions the value of the premium its intrinsic value and the option s time value the amount of time remaining before a contract s expiration if an option is close to its expiration it s unlikely an investor will get much return for selling the option early because there s little time left for the option to make money in this case the option s worth rests on its intrinsic value an assumed price based on if the contract is in out or at the money atm european option vs american optioneuropean options can only be exercised on the expiration date whereas american options can be exercised at any time between the purchase and expiration dates in other words american options allow investors to realize a profit as soon as the stock price moves in their favor and enough to more than offset the premium paid investors will use american options with dividend paying stocks in this way they can exercise the option before an ex dividend date the flexibility of american options allows investors to own a company s shares in time to get paid a dividend however the flexibility of using an american option comes at a price a premium to the premium the increased cost of the option means investors need the underlying asset to move far enough from the strike price to make the trade return a profit also if an american option is held to maturity the investor would have been better off buying a lower priced european version option and paying the lower premium lower premium costallows trading index optionscan be resold before the expiration datesettlement prices are delayedcannot be settled for underlying asset earlyexample of a european optionan investor purchases a july call option on citigroup inc with a 50 strike price the premium is 5 per contract 100 shares for a total cost of 500 5 x 100 500 at expiration citigroup is trading at 75 in this case the owner of the call option has the right to purchase the stock at 50 exercise their option making 25 per share profit when factoring in the initial premium of 5 the net profit is 20 per share or 2 000 25 5 20 x 100 2000 let s consider a second scenario whereby citigroup s stock price fell to 30 by the time of the call option s expiration since the stock is trading below the strike of 50 the option isn t exercised and expires worthless the investor loses the premium of 500 paid at the onset the investor can wait until expiry to determine whether the trade is profitable or they can try to sell the call option back to the market whether the premium received for selling the call option is enough to cover the initial 5 paid is dependent on many conditions including economic conditions the company s earnings the time left until expiration and the volatility of the stock s price at the time of the sale there s no guarantee the premium received from selling the call option before expiry will be enough to offset the 5 premium paid initially 