What it is:
How it works/Example:
Suppose an investor, John, buys a European call option on March 1st that expires on the third Friday in March. During the second week of March, the value of the underlying asset rises above the strike price. The holder of the European option is unable to take advantage of this momentary opportunity to lock in a profit since the only date he can exercise this option is on its expiration date.
In contrast, American options may be exercised at any time from the date of purchase until expiration. The holder of an American option may decide that the value of his option has reached its best point, even if maturity has not been reached. Such an option could then be sold before maturity.
The owner of a European option, on the other hand, must wait until maturity. In the example above, John may find that the European option is worth less at maturity than when he purchased it. If he had held an American option, he might have been able to make a profit earlier in the life of the option.
Why it matters:
European options usually trade at a discount to their American counterparts since there is only a single opportunity to exercise the option. If the holder of the European option doesn’t want to wait until the expiration date, he must close his position by selling the option. These options trade mainly over the counter and are rarely seen on the major exchanges.