Monday, July 12, 2010

European Style

How would you answer the following question?

A European-style option is considered a "derivative" because
A. the option may be exercised prior to expiration of the contract
B. the value of the contract is contingent on the value of some other thing
C. the option may be exercised only at expiration of the contract
D. the option contract is created and traded on a non-US exchange

EXPLANATION: you do need to know that a European-style option can be exercised only at expiration. If you know that, you can eliminate Choice A, which describes "American-style" options. The option contract can trade on a US Exchange, so you can eliminate Choice D. Is Choice C true? Not within the context of this question. Yes, European-style options may be exercised only at expiration, but that is not what makes them "derivatives." Believe it or not, what makes them derivatives is the fact that they derive their value based on some other thing, i.e. a stock, or an index.


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