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Option Styles

Options

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There are many option styles that can be divided into categories by their actual function. These divisions offer varying strategic options for writers and buyers, and the one you use should be dependent on your goals and your investment strategy. All of these options can only be exercised once.

The first division in Option Styles is created by their regional nickname. American, European, and Asian options all have varying exercise times. Note that these are not region limited. The name merely refers to the style, and they can trade on markets on exchanges outside the continental name.

American Style

An American Style option can be exercised before its expiration date. Any time your option is “in the money” you can exercise it to seize your profit. This gives your exit strategy increased flexibility. If you’re buying the option, American options give you control as long as you’re in the money. If you’re writing the option, this gives flexibility and control to the holder. They can exercise against you any time the option is in the money.

European Style

European Style options can only be exercised on their expiration date. They cannot be used before that date even if they are in the money. They restrict your control and flexibility if you’re the holder, since your ability to call is restricted. This favors the writer of the option, who can’t be exercised against unless the call is in the money on the expiration date.

Asian Style

An Asian Style option is even more complicated. These options cannot be exercised unless the underlying asset’s average market price was above a set level before a date specified in the option. The average price of the underlying asset must be above a set price for the majority of that time. It still can’t be exercised until after the time period ends. The option’s usefulness depends on your needs in relation to volatility and hedging of underlying prices, the time period, and the set level the average price must exceed.

Barrier Option

A Barrier Option adds a differing variable to the expiration date relation. There are two primary flavors to these options: a knock-out, and a knock-in. A knock-out option will expire if the price crosses a certain line. A knock-in option will expire unless the price crosses over a certain line. The option quality, for both writers and holders, depends on the quality of the requirements.

Capped Option

A Capped Option has a price cap that is stated in advance. If the option is a call, the price cap is above. If the option is a put, the price cap is below. The option is automatically exercised when the price cap is reached. A holder will automatically purchase the underlying asset if it is a call, or will automatically sell the underlying asset if it is a put.

Look Back Option

A Look Back Option allows the holder to pick the price at which their option was deepest “in the money”, and exercise the option accordingly. If the option is a call, the holder can exercise at the highest point over the course of the option, not just the market price on the date of expiration. If the option is a put, the holder can exercise at the lowest point over the course of the option, on the day of expiration. This allows the holder to select their profit above the strike price. In exchange for this privilege, you will pay a very high premium to the writer. If you are the writer, you’ll receive a high premium and hope the asset never goes deep in the money.

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