American option

An option that can be exercised at any time up to expiry. Worth at least as much as the equivalent European option; in a binomial tree it is valued with a check for exercise at each node.

Where you will meet it

American option appears in 3 learning outcomes on the CFA syllabus. A few of them:

• Spot an options arbitrage opportunity and set out the trades that exploit it
  CFA Level II · Derivatives and Risk Management

  “For American options another check applies: an option trading below its exercise value can be bought and exercised at once, a put together with buying the share.”

• Use a two-period binomial model to work out no-arbitrage values for American and European options
  CFA Level II · Derivatives and Risk Management

  “An American option adds a check at each earlier node: its value there is the larger of the rolled-back value and the value of exercising now.”

• Name the assumptions behind the Black–Scholes–Merton model for valuing options
  CFA Level II · Derivatives and Risk Management

  “The model does still price an American call on a non-dividend-paying share, since early exercise is never optimal for it while interest rates are not negative.”

See also

Binomial tree · European option

Practise it

• Today's practice question One question, with every wrong option explained.
• Free Level I diagnostic test Twelve questions that show which topics to start with.
• Free finance calculators Check your arithmetic on the exam's core formulas.

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