Why European Options Are Taught Before American Options
Summary
The document explains why education and literature often emphasize European option pricing even though many real options and traded contracts allow early exercise. European options provide a simpler setting for teaching derivative pricing because exercise occurs only at expiration. A typical learning path introduces payoff and pricing concepts with a binomial tree, then develops Black–Scholes–Merton as a continuous-time limit, before addressing early-exercise problems.
The answers note that Black–Scholes–Merton applies directly to European options under its assumptions, with particular American-option cases such as calls on non-dividend-paying underlyings also covered. A binomial model can handle American and Bermudan exercise by evaluating early exercise at relevant steps, though that adds complexity. The discussion supports European pricing as a foundation for learning, not as a claim that it is sufficient for all practical contracts. It offers no empirical comparison or detailed treatment of model assumptions, optimal stopping, or when early exercise is valuable.
Key ideas
- European options are simpler teaching examples because they cannot be exercised before expiration.
- Binomial trees introduce core pricing concepts and can be extended to early-exercise contracts.
- Black–Scholes–Merton provides a foundational model for European options under specified assumptions.
- American-option pricing requires accounting for the possibility of exercise before expiration.
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Full text
# If most real options are American, why so much focus on European option pricing? # If most real options are American, why so much focus on European option pricing? At my university, there is a compulsory course in European option pricing (centered around Black Scholes formula). But the course on optimal stopping theory (which is needed for American options) is an elective course. If most real options are American, why so much focus on European option pricing in the literature and at universities? For example, why is the Black Scholes formula so important? If it's for European options, and most options are American, then why do we care so much? ## Answer by Valometrics.com (score 4) https://quant.stackexchange.com/a/51033 There is so much focus on european options because of it's more easy for learning purpose. One can't start teaching options that's are more complicated before explaining the basic style of options. In most of mathematical finance books, they start by binomial tree for european options then they deal with black and scholes formula as a limit of binomial tree when time stamp tend to zero. Once this is done, they start showing the pricing of american options. it's more logical to do it this way! ## Answer by user9875321__ (score 0) https://quant.stackexchange.com/a/51035 I agree completely with @Valometrics 's answer. European options are more easy to handle as they are not affected by the chance to be exercised before expiration. Moreover: the Black-Scholes-Merton model (1973) can be applied only to European options with underlying which pay and do not pay dividends, and to American call which do not pay dividends. Using the Cox, Ross, Rubinstein model (1978) one can price any type of options (even Bermudan). However, it is much easier to do it for European rather than for American options. Hence European options are used mainly to illustrate the fundamental concepts related to this derivative. In practice it is more likely you have to deal with American options. But you will be able to handle them only after mastering the workings of European ones. That is the rationale behind this praxis.
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