European options

Definition

European options are financial derivatives that can only be exercised at their expiration date, not before. They are commonly used in risk management and hedging strategies to mitigate potential financial losses.

5 Must Know Facts For Your Next Test

1. European options can only be exercised on their expiration date, unlike American options which can be exercised at any time before expiration.
2. They are often used in hedging strategies to manage exchange rate risk.
3. The pricing of European options is typically modeled using the Black-Scholes formula.
4. European options are less flexible but generally simpler to price compared to American options.
5. These options play a crucial role in international finance for managing risks associated with foreign investments and exchange rates.

Review Questions

• What is the main difference between European and American options?
• Why might a financial manager choose a European option over an American option?
• How is the pricing of European options typically determined?

Related terms

American Options: Financial derivatives that can be exercised at any time before their expiration date.

Black-Scholes Model: A mathematical model used for pricing European call and put options.

Hedging:

A risk management strategy used to offset potential losses from price fluctuations in financial markets.