European Option

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Definition of 'European Option'

A European option is a type of option contract that can only be exercised on the expiration date. This is in contrast to an American option, which can be exercised at any time before the expiration date.

European options are typically used for hedging purposes, as they provide a way to lock in a price for an underlying asset at a future date. For example, a farmer might buy a put option on corn futures to protect against the possibility of a decline in the price of corn. If the price of corn does decline, the farmer can exercise the put option and sell the corn at the strike price, locking in a profit.

European options are also used for speculation, as they offer the potential for unlimited gains. For example, an investor might buy a call option on a stock that they believe is going to increase in value. If the stock does increase in value, the investor can exercise the call option and buy the stock at the strike price, locking in a profit.

The price of a European option is determined by a number of factors, including the strike price, the underlying asset, the time to expiration, and the volatility of the underlying asset.

European options are a complex financial instrument, and investors should carefully consider the risks involved before trading them.

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