American vs European Options

B is correct. Early exercise to capture the $3 dividend is advantageous here. By exercising, Sarah buys 1,000 shares at $60 (total $60,000) when the market price is $85 (total $85,000), locking in $25,000 intrinsic value. She receives the $3,000 dividend ($3 × 1,000 shares) tomorrow. While she forfeits $2,000 in time value, she gains $3,000 in dividends, netting $1,000 advantage. After the ex-dividend date, the stock drops to approximately $82, but Sarah already owns shares at $60 with the dividend captured. This is a classic American option advantage: early exercise for dividend capture when dividend exceeds time value.

A is incorrect because holding until expiration means missing the $3 dividend, which exceeds the $2 time value. After the ex-dividend date, the stock will drop to ~$82, reducing option value. C is neutral but less advantageous: selling at $27 captures both intrinsic and time value ($27,000 total), but exercising and capturing the dividend yields $25,000 intrinsic + $3,000 dividend = $28,000, which is $1,000 better. D is nonsensical: you cannot convert option exercise styles. American vs European is determined at contract creation.

B is correct. This accurately defines the fundamental difference: American options provide the right to exercise at any time from purchase until the expiration date, while European options can only be exercised on the expiration date itself. This exercise timing flexibility is the sole distinction between the two styles and affects option valuation (American options typically cost more due to greater flexibility).

A is backwards: it reverses the definitions, incorrectly stating American options can only be exercised at expiration. C is incorrect because the names refer to exercise timing, not geographic location. European-style options trade on US exchanges (e.g., SPX index options are European-style but trade on US exchanges), and American-style options can trade anywhere. D is incorrect because both American and European options have standard expiration dates (typically the third Friday of the expiration month for equity options). The difference is when they can be exercised, not when they expire.

A is correct. American-style options should trade at a premium (higher price) compared to otherwise identical European-style options because American options provide additional rights: the flexibility to exercise early if advantageous (dividend capture, deep in-the-money positions, locking in profits, avoiding assignment risk). More rights = higher value. The American option has all the rights of the European option PLUS the early exercise feature, justifying a higher premium.

B is backwards: greater rights (American) command higher prices, not lower. European options have MORE assignment risk from the seller perspective because sellers know exactly when potential assignment occurs (at expiration only), but this does not add value for buyers. C is incorrect because while both options have identical intrinsic value ($10 = $110 - $100), the American option has additional optionality value from early exercise rights, making it worth more. D incorrectly suggests the European option trades at a discount to account for missed dividends, but the American option should trade at a premium to reflect its ability to capture those dividends through early exercise.

C is correct (the EXCEPT answer). This statement is FALSE. European options CAN be sold (closed) in the market before expiration at their current market value. They simply cannot be EXERCISED early. The restriction is on exercise timing, not on trading or closing the position. An investor holding a European option can exit the position anytime by selling the option, realizing gains or losses based on current market price. Only the exercise feature is restricted to expiration.

A is accurate: American options provide the right to exercise at any point from purchase through the expiration date, offering maximum flexibility. B is accurate: European options restrict exercise to the expiration date only, with no early exercise permitted regardless of how profitable early exercise might be. D is accurate: most individual stock and ETF options traded on US exchanges (CBOE, NYSE) are American-style, while index options (like SPX, NDX) are typically European-style. This is an important distinction for practical option trading.

A is correct. Only statements 1 and 3 are accurate.

Statement 1 is TRUE: American options trade at higher premiums than otherwise identical European options because they provide additional exercise flexibility. More rights (early exercise) = higher value. The American option contains all rights of the European option PLUS early exercise capability, justifying a premium price.

Statement 2 is FALSE: European option SELLERS face assignment risk only at expiration, not anytime before. Since European options can only be exercised at expiration, sellers know exactly when assignment might occur. American option sellers face assignment risk at any time before expiration because buyers can exercise whenever they choose.

Statement 3 is TRUE: Early exercise of American call options is most advantageous when a stock pays a dividend that exceeds the remaining time value of the option. By exercising early, the investor captures the dividend while forfeiting time value. If dividend > time value, early exercise is profitable. This is the classic dividend capture scenario and a key advantage of American options.

Statement 4 is FALSE: Index options like SPX are typically EUROPEAN-style, not American-style. Most individual stock options are American-style, but major index options are European-style, exercisable only at expiration. This prevents disruption from early exercise in index option markets.