The different phrases style and type can be quite confusing. Thesaurus.com lists the following synonyms for the word “style”: characteristic, design, form, kind, method. Let’s get more precise in the context of currency options.
The style of an fx option determines when an option can be exercised.
There mainly exist three families of option styles:
- European style options
- American style options
- Bermuda style options
Differences between American and European Option Styles
American style options can be exercised at any time before their expiration. European style options may only be exercised when they expire.
That’s why American style options have a higher price tag than European style options when the other parameters are the same. Simply put, American style options offer us more possibilities for making a profit.
This is due to the fact that we can take advantage of a market situation in our favor anytime until the expiration. Hence, there must be a higher premium to compensate the issuer for carrying higher risk. This effect is called “Ameriplus”.
However, keep in mind that exercising an American style option wipes out the entire time value of the option price. In general, the time value is very high during the first phase of an option’s lifetime cycle. Therefore, it’s usually only profitable at an early stage if our position is deeply In The Money.
Bermuda style options – a Hybrid
There’s a third style which is more exotic. Bermuda style options consist of hybrid contracts. These contracts specify at what dates an option may be exercised.
Most often, Bermuda options are cheaper than their American pendants while being a bit less restrictive compared to the European counterparts. They are suitable alternatives if you are trading forex options and looking for a compromise between price and flexibility.
What is the option style?
The style determines when an option may be exercised.
Which option styles exist?
There are European style and American style options. Bermuda options are a hybrid style.