Hi, I have a question regarding some strategies in our course that are said to be applicable only to European options, like selling straddles and closing positions based on IV Rank and Skew Rank.
To my understanding, these concepts are also highly relevant to any options market. Could these analyses also be applied effectively to American options? If so, what additional factors should we consider, especially given the early exercise feature of American options?
Hi Luis,
Yes, concepts like IV Rank and Skew Rank are highly relevant for both European and American options. However, American options have an added layer of complexity due to their early exercise feature, which isn't present in European options.
So, early exercise risk is the major factor that should be considered while trading American options. To be specific, american options can be exercised before expiration, often when deep in-the-money, especially around dividend dates. This can disrupt strategies like selling straddles by triggering unexpected assignments.
Not only this, Unlike European options, time decay in American options is less predictable because holders might exercise early if it's profitable and calls may be exercised early to capture dividends, affecting strategies that involve selling calls.
So, when trading American options, it's crucial to be mindful of dividend dates to avoid the risk of early exercise, especially when selling calls. To minimise the chances of unexpected assignments, you might prefer selling shorter-dated options, as these have less time for the holder to exercise early.
Also, focusing on liquid markets can help reduce the risk of mispricing and improve trade efficiency. Additionally, consider hedging your positions to manage potential early exercise risks, ensuring that you’re prepared for sudden market moves that could impact your strategy.
Let us know if you have any more questions on this.