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.