Exploring Different Option Types

If you are new to the world of options, you soon realize that you have several different ways to invest based on option type. An option is a method to invest that many people are not familiar with. Many investors think that there are stocks, mutual funds, and bonds and that is about it. However, if you are limiting yourself to those choices, you are missing out on a very rewarding type of investing through options. An option is a contract that gives you the right to buy a particular asset at a specific price on or before a given date. While it gives you the right, it does not carry with it any obligation. Therefore, options are actually one of the most flexible investments that you can find anywhere. With so many different ways to invest in options, it can be hard to keep up with all of the different types that are available. Here are a few different option types that you could invest in. 

American Options

An American option does not necessarily mean that is where the option originated. You can trade an American option from anywhere in the world. The term American option refers to the way that the option is exercised. With an American option, you can exercise the option contract at any time during the life of the contract. You could exercise it a few days after you open the contract or you could wait until the day of the expiration date.

The flexibility of an American option gives it the most value of any type of option out there. You can do what you want with it and there are no penalties to pay. You could exercise the option, trade out of it, or simply let it expire. Regardless of what you decide to do with the option, it is ultimately your choice. Choice creates more value in the eyes of investors. 

European Options

The main counterpart to American options are European options. This form of investment also gives you the ability to buy a specific asset but not the obligation to do so. The main difference with this type of option is that you can only buy the asset on a specific date in the future. For example, you might set up a European option that says you can buy 100 shares of the Widget Corporation on July 17th at $4.00 per share. Between now and then the price goes up to $10.00 per share, but you cannot exercise your option until July 17th. By the time July 17th arrives, the stock is only worth $2.00 per share. This means that you will most likely decide not to exercise your option since you would be losing money on the transaction.

This example illustrates why European options are not as valuable as their American counterparts. If you had an American option in that situation you would have theoretically been able to buy the stock at $4.00 per share when the value went up to $10.00 per share. 

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