A European option is a type of financial derivative contract that gives the holder the right (but not the obligation) to buy (call option) or sell (put option) an underlying asset at a predetermined price (strike price) on or before the expiration date. The key characteristic of a European option is that it can only be exercised at the expiration date, not before.

Key features of European options:

1. **Exercise Restriction:**
– The distinguishing feature of a European option is that it can only be exercised at the expiration date. This is in contrast to American options, which can be exercised at any time before or on the expiration date.

2. **Expiration Date:**
– European options have a specific expiration date, also known as the maturity date. It is the point in time when the option contract ceases to exist, and the rights of the option holder expire.

3. **Settlement Styles:**
– European options can have different settlement styles, depending on the type of option:
– **Cash Settlement:** The option is settled in cash at expiration, with the difference between the asset’s market price and the strike price determining the cash payment.
– **Physical Settlement:** The actual underlying asset is exchanged between the option buyer and seller at the predetermined price.

4. **Typical Underlying Assets:**
– European options can be written on a variety of underlying assets, including stocks, bonds, commodities, and financial indices.

5. **Call and Put Options:**
– A European call option gives the holder the right to buy the underlying asset at the strike price, while a European put option gives the holder the right to sell the underlying asset at the strike price.

6. **Premium Payment:**
– Option buyers pay a premium to the option sellers for the rights embedded in the option contract. The premium is the price of the option and is determined by factors such as the current market price of the underlying asset, the strike price, volatility, and time to expiration.

7. **Risk Management and Speculation:**
– European options are commonly used for risk management and speculation. Businesses may use them to hedge against adverse price movements, while investors may use them to take directional bets on the future price movements of the underlying assets.

8. **Options Pricing Models:**
– Various mathematical models, such as the Black-Scholes model, are used to estimate the fair value of European options. These models take into account factors like the current stock price, the option’s strike price, time to expiration, volatility, and interest rates.

9. **Liquidity and Trading:**
– European options are actively traded on various financial exchanges. Liquidity and trading activity can vary depending on the specific underlying asset and market conditions.

10. **Role in Portfolios:**
– Traders and investors often incorporate European options into their portfolios to manage risk or generate potential returns. The use of options requires an understanding of the associated risks and a clear strategy.

It’s important for investors and traders to carefully consider the characteristics and risks associated with European options and to have a solid understanding of the factors influencing their pricing and performance. Additionally, individuals should be aware of the specific terms and conditions outlined in each option contract.