European Option
Candlefocus EditorEuropean options present a number of advantages to traders, beginning with the lower-than-usual cost of the option premium. Another primary benefit, which is unique to European options, is that investors are able to sell back their contract to the market before expiry and receive the net difference between the premiums they paid and earned. An additional benefit of European options is that they are rarely subject to early exercise risk (i.e. exercising the option before expiration).
Other key characteristics of European options include the fact that many index options are traded using European options. As a result, traders seeking exposure to those indexes must become familiar with this version of the options contract.
To value the European option, there are several pricing models that can be used. The Black-Scholes option model remains popular because it is efficient and easy-to-use.
Overall, European options provide a valuable mechanism to gain exposure to the stock market and hedge risk. The lower cost and reduced risk of early-exercise make European options attractive to many traders. With a basic understanding of how they work, investors can make informed decisions regarding these sophisticated financial instruments.