American or European?

One interesting strategy that many people forget about is the origin of the option that will be used. You have two options:

1. The American Option - An American option lets you exercise the option at any point up until the expiration date. You are not necessarily obligated to buy shares or sell within a time period. You just have the right to do so.
2. The European Option - A European option allows you to exercise the option only at the end of the term. That is, you still have the right to buy or sell the shares, but you do not have as much freedom for handling it at this juncture.

These are two different option styles clearly state when they are to be exercised. As you will see next, there are many things that make these two options different from one another.

Features of the American Option

An American option often works with a specific schedule for when you can enter into it. You might have the option to get into a 30-day option or even a 14-day option. That option will end trading at the end of the business day on the third Friday of the month in which it expires. This should give you an idea of when you would have to enter into an option.

You can still enter into the option after it has started. At that point, you would have to look into the time value of that option to see if it is worthwhile or if the risk is too high. The settlement price for the option is based on when the trading period ends. After-hours trading is not factored into the process.

Features of the European Option

The European option is important as well. The European option stops trading a day earlier. It stops on the third Thursday of the month in which the option expires. This is a simple difference, but it can make an impact as to how the value might change. In fact, avoiding the third Friday of the month might be great as you will avoid the last rush for trading on Friday where the price of the underlying stock might become hard to predict. The settlement price is not revealed until a few hours after the market is open for trading.

Which Is Better?

If you want a little more flexibility, you should choose the American option for your strategy. The European option might work if you want to avoid risking dramatic Friday shifts.