American Option

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.

 

 

 

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