502 Part V: Index Options and Futures 
options have the European exercise feature. All stock options and some index options 
have the American exercise feature. 
The European exercise feature was introduced because institutional investors 
who might tend to write calls against their portfolio of stocks wanted some assurance 
that their protection wouldn't be unexpectedly taken away from them. Thus several 
index option series became European exercise. Two major ones are the cash-based 
index options on the S&P 500 Index (SPX) and the cash-based options on the Dow­
Jones 30 Industrials. OEX remains an American exercise. 
In-the-money European put options will be cheaper than their American coun­
terparts. This is because an arbitrageur would have to carry the position all the way 
to expiration; he could not exercise his puts and liquidate the position immediately. 
In fact, deeply in-the-money European puts will trade at a discount; the higher short­
term interest rates are, the deeper the discount will be. 
This can affect the full protective capability of long-term European puts. If a 
portfolio manager buys puts to protect his portfolio and the market crashes, the puts 
might be deeply in the money. If these puts have a European exercise feature, they 
would be selling at a deep discount and therefore would not have afforded all the 
price protection that the portfolio manager had been looking for. 
American Exercise Consideration. The primary reason for the holder of an 
index option to exercise the option is to take his profit. One might think that, if the 
holder wanted to take a profit, he would merely sell his option in the open market. 
Of course, if he could, he would. However, many times the deeply in-the-money 
options sell at a substantial discount during the trading day. A deep discount is con­
sidered to be 1/2 to 3/4 of a point, or more. Near the end of the day, these options 
tend to trade at only slight discounts. In either case, the holder of the option may 
decide to exercise rather than to sell at any discount. Of course, if one is the holder 
of a call option that is trading at a substantial discount in the morning of a particular 
day, and he decides to exercise, he may lose more by the end of the day (if the mar­
ket trades down) than he would have if he had merely sold at the deep discount in 
the first place. In fact, some theoreticians feel that the "job" of a deeply in-the-money 
cash-based option during the trading day is to try to predict the market's close. This, 
of course, is not a "job" that can be consistently done with accuracy (if it could, the 
traders doing the predicting would be rich beyond their wildest dreams). 
If the holder of a cash-based call option turned bearish, that would be another 
reason to exercise. That's right - if the holder of a cash-based call option is bearish, 
he should exercise because, by so doing, he liquidates his bullish position and takes 
his profit. This is somewhat opposite from an option that has a physical underlying 
security, such as a stock option. This presents an interesting scenario: If one turns