European option

An option that can be exercised only at expiry, so its value depends only on the payoff at that date. Never worth more than the equivalent American option, and the kind most pricing formulas value directly.

Where you will meet it

European option appears in 5 learning outcomes on the CFA syllabus. A few of them:

• Use put-call parity to link option prices with the underlying's price
  CFA Level I · Derivatives

  “For European options on an underlying that pays no income, the relationship is therefore not a model but an accounting identity enforced by arbitrage, which is why it holds regardless of what anyone thinks volatility will be.”

• Explain how a European option's value can be viewed as its expected payoff at expiry discounted to today
  CFA Level II · Derivatives and Risk Management

  “A European option is worth its expected payoff at expiry, taken with risk-neutral probabilities and discounted at the risk-free rate.”

• Use a two-period binomial model to work out no-arbitrage values for American and European options
  CFA Level II · Derivatives and Risk Management

  “A European option needs only the terminal payoffs.”

• Explain how the Black model values European options on futures contracts
  CFA Level II · Derivatives and Risk Management

  “The Black model prices European options on futures or forwards.”

See also

American option

Practise it

• Today's practice question One question, with every wrong option explained.
• Free Level I diagnostic test Twelve questions that show which topics to start with.
• Free finance calculators Check your arithmetic on the exam's core formulas.

All terms beginning with E · Glossary