American options are more expensive than European options because they give the buyer the right to early exercise.

But in a low interest environment, early exercise is a bad idea, for most retail traders at least.

So it seems like the extra premium paid for American option is not worth it. Is it true?


There are a few situations in which it may be advantageous to exercise early. Wikipedia actually has a good explanation:

Option Style, Difference in value

To account for the American's higher value there must be some situations in which it is optimal to exercise the American option before the expiration date. This can arise in several ways, such as:

An in the money (ITM) call option on a stock is often exercised just before the stock pays a dividend that would lower its value by more than the option's remaining time value.

A put option will usually be exercised early if the underlying asset files for bankruptcy.[3]

A deep ITM currency option (FX option) where the strike currency has a lower interest rate than the currency to be received will often be exercised early because the time value sacrificed is less valuable than the expected depreciation of the received currency against the strike.

An American bond option on the dirty price of a bond (such as some convertible bonds) may be exercised immediately if ITM and a coupon is due.

A put option on gold will be exercised early when deep ITM, because gold tends to hold its value whereas the currency used as the strike is often expected to lose value through inflation if the holder waits until final maturity to exercise the option (they will almost certainly exercise a contract deep ITM, minimizing its time value).[citation needed]

Not the answer you're looking for? Browse other questions tagged or ask your own question.