Binary option american style European option may be exercised only at the expiration date of the option, i. An American option on the other hand may be exercised at any time before the expiration date. Where K is the strike price and S is the spot price of the underlying asset.
Option contracts traded on futures exchanges are mainly American-style, whereas those traded over-the-counter are mainly European. Nearly all stock and equity options are American options, while indexes are generally represented by European options. Commodity options can be either style. Traditional monthly American options expire the third Saturday of every month. They are closed for trading the Friday prior. Expire the third Friday if the first of the month begins on a Saturday. European options expire the Friday prior to the third Saturday of every month.
Therefore, they are closed for trading the Thursday prior to the third Saturday of every month. Assuming an arbitrage-free market, a partial differential equation known as the Black-Scholes equation can be derived to describe the prices of derivative securities as a function of few parameters. An investor holding an American-style option and seeking optimal value will only exercise it before maturity under certain circumstances. Owners who wish to realise the full value of their option will mostly prefer to sell it on, rather than exercise it immediately, sacrificing the time value. If it is worth more, then the difference is a guide to the likelihood of early exercise.
To account for the American’s higher value there must be some situations in which it is optimal to exercise the American option before the expiration date. A put option will usually be exercised early if the underlying asset files for bankruptcy. ITM and a coupon is due. A Canary option is an option whose exercise style lies somewhere between European options and Bermudian options.