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6.1 American stock options

The American exercise style differs from its European counterpart only because of the time when the contract comes into life: the European option can only be exercised on the expiry date, whereas the American option can be exercised any time up to this expiry date. This additional right granted to the holder of an American contract has a value and affects the price of American options before they expire.

The first part of this chapter examines the payoff from American options, using stock market derivatives to illustrate a feature that can be added to a large variety of financial derivatives, where the price of an underlying good is obtained from a consensus between offer and demand.