American Option

The American option's early exercise privilege gives it a value equal to or greater than an otherwise identical European option, generates the concept of the early exercise premium, creates distinct circumstances in which early exercise is and is not rational, and places unique obligations on options sellers who face the risk of assignment on any trading day their short option position remains open. 

This entry examines the defining characteristics of American options in precise technical detail, explains the early exercise decision framework for both calls and puts, analyses the critical role of dividends and interest rates in the early exercise calculus, describes the exercise and assignment process through the Options Clearing Corporation and FINRA rules governing broker-dealer obligations, contrasts American and European option pricing, and identifies which major option products traded on United States markets use each exercise style.

Definition and Overview

An American option is any options contract in which the holder retains the right to exercise — to invoke the right to buy the underlying security at the strike price in the case of a call, or to sell it at the strike price in the case of a put — on any business day from the transaction date through the final expiration date of the contract. The term American refers to the exercise style of the contract, not to any geographic constraint on who can buy or sell it.

Every standardised equity option listed on a United States national securities exchange — including options traded on the Chicago Board Options Exchange, NYSE Arca, Nasdaq ISE, Cboe BZX, and other registered options exchanges — is an American-style contract, as confirmed by the Options Clearing Corporation's equity options product specifications, which state that equity options may be exercised on any business day up to and including the expiration date. 

Exchange-traded fund options are also American-style. 

This means that the vast majority of individually named options contracts that a Series 7 registered representative will encounter in practice are American-style instruments.

The exercise privilege of an American option is unconditional — the holder may exercise at any time regardless of whether doing so is economically optimal. 

The obligation to fulfil the terms of the contract upon exercise falls immediately on the seller of the option, who may receive an assignment notice from the Options Clearing Corporation at any time the short position remains open.

The Relationship to European Options

The European option is the primary contrast to the American option — a contract in which exercise is restricted to the expiration date only. 

European options cannot be exercised early under any circumstances, regardless of how deep in the money they become or how significant the upcoming dividend on the underlying security is.

In United States markets, European-style options are most commonly associated with broad market index options rather than individual equity options. The S&P 500 Index options traded on the CBOE under the ticker SPX are European-style — they can only be exercised at expiration and settle in cash based on the opening prices of the index components on expiration morning. 

The OEX options, which are options on the S&P 100 Index, are American-style — they can be exercised before expiration. SPDR S&P 500 ETF options, which track the same S&P 500 Index but through the exchange-traded fund structure rather than through the index itself, are American-style. 

This distinction between SPX and SPY options — the former European-style and cash-settled, the latter American-style and physically settled — is a frequently tested point on Series 7 and Series 65 examinations.

FINRA's investor guidance confirms that in United States markets the majority of options on commodity and index futures are European-style, while options on stocks and exchange-traded funds are American-style, and that American-style options sellers face the risk of assignment on any day equity markets are open.

Valuation — Why American Options Are Worth at Least as Much as European Options

A fundamental principle of options theory holds that an American option is always worth at least as much as an otherwise identical European option — same underlying, same strike price, same expiration date, same type. 

This principle is intuitive: the American option confers everything the European option confers — the right to exercise at expiration — plus the additional right to exercise early on any prior trading day. An additional right can never have negative value. Therefore the American option price is always greater than or equal to the European option price.

The difference between the price of an American option and an otherwise identical European option is called the early exercise premium. The early exercise premium reflects the market's assessment of the probability and value of exercising early — the incremental value of having the option to exercise before expiration. When early exercise is never optimal, as is the case with American call options on non-dividend-paying stocks, the early exercise premium is zero and the American option price equals the European option price. When early exercise may be optimal under certain conditions, the early exercise premium is positive.

Pricing Models — Binomial Versus Black-Scholes

The Black-Scholes model, developed by Fischer Black and Myron Scholes in 1973, was derived under the assumption that the option can only be exercised at expiration — it is a European option pricing model. For American options on non-dividend-paying stocks, the Black-Scholes model produces accurate prices because it has been demonstrated mathematically that early exercise is never optimal for such options and the early exercise premium is therefore zero. For American put options and for American call options on dividend-paying stocks, however, the Black-Scholes model can undervalue the option by failing to account for the circumstances in which early exercise is rational.

The binomial option pricing model, developed by Cox, Ross, and Rubinstein in 1979, was specifically designed to value American options. It constructs a tree of possible stock prices over the life of the option, working backward from expiration to the present. At each node of the tree — each possible price point at each possible time step — the model compares the value of holding the option against the value of exercising immediately, and assigns the maximum of the two as the option value at that node. This backward induction process correctly identifies all circumstances in which early exercise is optimal and produces accurate American option prices. Because most equity options traded on United States exchanges are American-style, the binomial model is the theoretically correct tool for their valuation, though in practice Black-Scholes is widely used as a practical approximation for options on non-dividend-paying or low-dividend-paying stocks.

When Is Early Exercise Rational? — The Framework

The decision to exercise an American option early — before expiration — involves a fundamental tradeoff between capturing the option's intrinsic value immediately and preserving its time value, which represents the additional worth of having the right to change course before expiration. Exercising early discards the remaining time value of the option, which is almost always worth something positive. Early exercise is therefore only rational in specific and definable circumstances in which the benefits of immediate exercise outweigh the cost of surrendering time value.

Early Exercise of American Calls — The Dividend Scenario

For an American call option on a stock that pays no dividends, early exercise is never optimal. This is a mathematically provable result, first demonstrated by Robert Merton in 1973. The reasoning is as follows: if the holder exercises the call early, they pay the strike price today and receive the stock. By not exercising, they retain the strike price in cash — which earns a risk-free return until expiration — and retain the option's protection against the stock falling below the strike price before expiration. The interest earned on the deferred strike payment, plus the insurance value of the remaining option, always exceeds the benefit of owning the stock outright before expiration. On a non-dividend-paying stock, there is never a benefit to owning the stock early rather than retaining the option, so early exercise is never rational and the American call price equals the Black-Scholes European call price.

The analysis changes decisively when the underlying stock is about to pay a dividend. A stock's price falls by approximately the amount of the dividend on the ex-dividend date — an event that directly reduces the value of the call. The holder of a call option has no right to receive dividends — that right belongs to stockholders of record, not to option holders. If the holder exercises the call the day before the ex-dividend date, they acquire the stock and become entitled to receive the upcoming dividend. This dividend receipt may more than compensate for the time value surrendered by early exercise if the dividend is sufficiently large relative to the option's remaining time value.

The practical rule for early exercise of an American call to capture a dividend is that exercise is rational only immediately before the ex-dividend date — not earlier — and only when the dividend exceeds the remaining time value of the corresponding put plus the opportunity cost of paying the strike price early. This is the classical condition derived from put-call parity analysis. Option writers who are short call options on dividend-paying stocks should be aware that early assignment is most likely to occur the day before a significant ex-dividend date, as call holders seek to capture the upcoming dividend.

The Options Education Council and CBOE educational materials both confirm that call writers should be aware of dividend dates and the possibility of early assignment, with early assignment most probable when the call is deep in the money and a large dividend payment is approaching.

Early Exercise of American Puts — The Interest Rate Scenario

American put options present a different and in some ways richer early exercise analysis. Unlike calls, early exercise of American puts can be rational even on stocks that pay no dividends — a fact that distinguishes puts from calls and creates a genuine early exercise premium on put options even in the absence of dividends.

When an investor exercises a put option, they sell the underlying stock at the strike price and receive immediate cash equal to the intrinsic value of the put. This cash can then be invested at the risk-free interest rate from the date of early exercise through the original expiration date — earning interest that would not be available if the holder waited until expiration. For a deep in-the-money put with little remaining time value, this interest on the intrinsic value may outweigh the time value surrendered by early exercise.

The deeper in the money the put is — meaning the more the strike price exceeds the current stock price — the smaller the remaining time value, because the put is highly likely to expire in the money regardless of future price movements. When the intrinsic value is very large and the time value very small, the interest available on the exercise proceeds from now until expiration can exceed the time value cost of early exercise, making early exercise rational. Higher interest rates increase the attractiveness of early exercise for puts because they increase the value of the interest that can be earned on the proceeds. Lower interest rates reduce this incentive.

Most professional options traders exercise deep in-the-money put options early when there is sufficient time remaining to earn meaningful interest on the exercise proceeds. This is confirmed by the Options Education Council, which states that when puts become deep in the money most professional option traders exercise before expiration.

Dividends make early exercise of puts less attractive. Because dividends reduce the stock price on the ex-dividend date, they increase the put's intrinsic value going forward — giving holders of in-the-money puts an incentive to wait for the dividend-related price decline before exercising, capturing additional intrinsic value. This is the opposite of the dividend effect on call options, where dividends increase the incentive for early exercise.

The Exercise and Assignment Process — The Options Clearing Corporation

The Options Clearing Corporation, universally known as the OCC, is the sole clearing agency for standardised equity options listed on national securities exchanges registered with the Securities and Exchange Commission. The OCC operates under the joint jurisdiction of the SEC and the Commodity Futures Trading Commission and guarantees the performance of every options contract it clears, eliminating counterparty risk by standing as the counterparty to every cleared options transaction.

When an options holder wishes to exercise an American option, the exercise process follows a defined sequence. The holder notifies their brokerage firm of the exercise instruction. The brokerage firm submits an exercise notice to the Options Clearing Corporation. The OCC then randomly assigns the exercise notice to one of its clearing members that has a short position in that particular options contract. The clearing member firm — which may or may not be the same firm that submitted the exercise notice — must then assign the exercise obligation to one of its customers who holds a short position in that option series. The broker-dealer may use any fair method to allocate the assignment to customer accounts, including random selection, a lottery basis, or first-in-first-out chronological assignment. Critically, FINRA rules and OCC procedures both prohibit a broker-dealer from assigning the exercise notice to the customer who can most easily afford it — assignment must follow one of the approved fair allocation methods without regard to the financial capacity of the assigned customer.

Upon receipt of assignment, the seller of the option has no discretion — they are obligated to fulfil the terms of the contract regardless of whether doing so creates a loss or is otherwise unwelcome. Assignment on a short call requires the call writer to deliver one hundred shares of the underlying stock at the strike price. Assignment on a short put requires the put writer to purchase one hundred shares of the underlying stock at the strike price and pay the corresponding cash.

Settlement of Exercised Equity Options

The exercise and assignment of equity options results in physical delivery of the underlying shares on a T-plus-one settlement basis — treating the exercise notice submission date as the equivalent of the trade date. An investor who exercises a call option on Monday receives one hundred shares per contract on Tuesday. An investor who exercises a put option on Monday must deliver one hundred shares per contract on Tuesday and receives cash equal to the strike price times one hundred. This T-plus-one settlement timeline differs from the T-plus-two settlement standard that applies to ordinary stock purchases and sales.

Each standard equity options contract covers one hundred shares of the underlying security. The premium is quoted per share — a premium of three dollars fifty cents represents a total contract cost of three hundred and fifty dollars. Strike price intervals are generally set in increments of two dollars and fifty cents for options with strike prices below twenty-five dollars, five dollar increments for strikes from twenty-five to two hundred dollars, and ten dollar increments for strikes above two hundred dollars, though exchange programs allowing non-standard intervals are common.

FINRA Rule 2360 governs the conduct of broker-dealers with respect to options and sets the exercise cut-off time for expiring options at five-thirty PM Eastern Time on the day of expiration. Brokerage firms may set an earlier exercise notification deadline for their clients but may not set a later one. Options that are in the money by at least one cent at expiration are automatically exercised by the OCC under its exercise-by-exception procedures unless the holder submits contrary exercise advice — a formal instruction to the OCC not to exercise despite the in-the-money status.

Automatic Exercise and Contrary Exercise Advice

The OCC's exercise-by-exception rule automatically exercises options that are in the money by at least one cent at expiration, ensuring that holders do not accidentally fail to exercise valuable contracts through administrative oversight. This automatic exercise protects holders whose options have intrinsic value but who have not explicitly submitted exercise instructions before the cutoff time.

Holders who do not wish to have their in-the-money option automatically exercised — perhaps because the intrinsic value is too small to cover transaction costs, or because the holder is concerned about overnight stock risk over a weekend following expiration — may submit contrary exercise advice before the exercise cutoff time, instructing the broker and through it the OCC not to exercise the contract. Once an exercise instruction or contrary exercise advice has been submitted, it is irrevocable.

Pin Risk for American Option Writers

An option is said to be at the pin when the underlying stock price closes exactly at the strike price on expiration day. Pin risk is the risk faced by the writer of an American option when the underlying price is at or very near the strike price at expiration, because the writer cannot determine with certainty whether assignment will occur. In-the-money options are automatically exercised, but options trading exactly at the strike have no intrinsic value and would not normally be exercised. However, if news emerges after the market closes on expiration day but before the exercise cutoff time — moving the stock price either above or below the strike on an after-hours basis — the holder may exercise or decline to exercise based on that post-close information. The writer therefore cannot be certain whether they will be assigned until after the exercise deadline has passed, creating uncomfortable uncertainty about their overnight position.

American Versus European — Which Product Is Which

For Series 7 candidates, correctly identifying which options products use American-style versus European-style exercise is a frequently tested competency. All individual equity options on common stocks, preferred stocks, and exchange-traded funds are American-style. Options on most domestic equity ETFs including SPDR S&P 500 ETF options are American-style. Broad index options including SPX options on the S&P 500 Index are European-style. OEX options on the S&P 100 Index are American-style. VIX options are European-style. Mini SPX options known as XSP are European-style. Most commodity futures options are American-style. Index futures options traded on United States futures exchanges are predominantly American-style.

The key distinction is the underlying — a direct index that cannot be physically delivered and settles in cash typically uses European exercise, while an ETF that can be delivered physically typically uses American exercise. This rule has exceptions and candidates should verify specific product specifications, but it provides a reliable general framework for classification.

Examination Relevance and Key Takeaways

American options are tested extensively on the SIE, Series 7, and Series 65 examinations in the context of options basics, exercise and assignment mechanics, pricing concepts, and the specific circumstances that make early exercise rational. Candidates must understand that American options can be exercised at any time before expiration while European options can only be exercised at expiration, that all individual equity options on United States exchanges are American-style, that the American option price is always at least as great as an identical European option price, that early exercise of American calls is rational only immediately before an ex-dividend date when the dividend exceeds the remaining time value, that early exercise of American puts may be rational when the put is deeply in the money and interest on the exercise proceeds exceeds the time value surrendered, and that the OCC randomly assigns exercise notices to clearing member firms who must then assign to customer accounts using a fair allocation method.

The core points to retain are these: an American option may be exercised at any time before expiration while a European option may only be exercised at expiration — all equity and ETF options on United States exchanges are American-style while major broad index options such as SPX are European-style; the American option is worth at least as much as an identical European option, with the early exercise premium reflecting circumstances where early exercise may be optimal; early exercise of an American call is never rational on a non-dividend-paying stock but may be rational immediately before an ex-dividend date when the dividend exceeds the remaining time value of the corresponding put plus the opportunity cost of paying the strike early; early exercise of an American put may be rational when the put is deeply in the money and the interest that can be earned on the exercise proceeds from the exercise date to expiration exceeds the time value surrendered by exercising early, with higher interest rates increasing and dividends decreasing the likelihood of early put exercise; the OCC processes exercise notices by randomly assigning them to clearing member firms who then allocate the assignment to customer short option holders through a fair method such as random, lottery, or first-in-first-out; FINRA Rule 2360 sets the exercise cutoff at five-thirty PM Eastern Time on expiration day; and options that are in the money by at least one cent at expiration are automatically exercised by the OCC under exercise-by-exception unless the holder submits contrary exercise advice.