The Financial Engineer

What is it ?

• An American Call is the right to purchase a specified quantity of an underlying asset, at an specific price, on or before an expiration date.
• An American Call is the right to sell specified quantity of an underlying asset, at an specific price, on or before an expiration date.

How is it constructed ?

• Premium paid for the right to buy , or received for having written options.
• Position is margined through a clearing house, to reduce the chance of either party defaulting while owing a large sum.

What is the payoff ?

Same payoff graph as European option.

When is it used ?

• Investors seeking leveraged exposure to an underlying.
• Most single stock options are in the American form.
• Calls enable investors to call the bottom of a downtrend while minimising potential losses.
• Long positions are taken with the expectation of higher volatility.
• Call overwriting strategies can increase the yield on a shareholding. All premium will be retained as a profit as long as the shares do not rise above the strike of the calls by expiry. 
• Plain vanilla options can be combined to create other strategies
• Early exercice can sometimes be beneficial:
•   Call – if dividend level high
•   Put – if interest rate high

What are the benefits ?

• Take advantages of price fluctuation in the underlying asset without risking more than a premium
• Geared exposure to an underlying price
• Insure against a fall in the price of the underlying
• Generate yield
• Defer the decision of buying the underlying asset during periods of price uncertainty.