What Is an American Option?

An American option, aka an American-style option, is a version of an options contract that allows holders to exercise the option rights at any time before and including the day of expiration. It contrasts with another type of option, called the European option, that only allows execution on the day of expiration.

An American-style option allows investors to capture profit as soon as the stock price moves favorably, and to take advantage of dividend announcements as well.

How American Options Work

American options outline the timeframe when the option holder can exercise their option contract rights. These rights allow the holder to buy or sell—depending on if the option is a call or put—the underlying asset, at the set strike price on or before the predetermined expiration date. Since investors have the freedom to exercise their options at any point during the life of the contract, American-style options are more valuable than the limited European options. However, the ability to exercise early carries an added premium or cost.

The last day to exercise a weekly American option is normally on the Friday of the week in which the option contract expires. Conversely, the last day to exercise a monthly American option is normally the third Friday of the month.

The majority of exchange-traded options on single stocks are American, while options on indexes tend to be European style.

American Call and Put Options

A long call option gives the holder the right to demand delivery of the underlying security or stock on any day within the contract period. This feature includes any day leading up to and the day of expiration. As with all options, the buyer does not have an obligation to receive the shares and is not required to exercise their right. The strike price remains the same specified value throughout the contract.

If an investor purchased a call option for a company in March with an expiration date at the end of December of the same year, they would have the right to exercise the call option at any time up until its expiration date.

American put options also allow the execution at any point up to and including the expiration date. This ability gives the buyer the freedom to demand the seller takes delivery of the underlying asset whenever the price falls below the specified strike price.

One reason for the early exercise has to do with the cost of carry or the opportunity cost associated with not investing the gains from the put option. When a put is exercised, investors are paid the strike price immediately. As a result, the proceeds can be invested in another security to earn interest.

However, the drawback to exercising puts is that the investor would miss out on any dividends since exercising would sell the shares. Also, the option itself might continue to increase in value if held to expiry, and exercising early might lead to missing out on any further gains.

When to Exercise Early

In many instances, holders of American-style options do not utilize the early exercise provision, since it’s usually more cost-effective to either hold the contract until expiration or exit the position by selling the option contract outright. In other words, as a stock price rises, the value of a call option increases, as does its premium. Traders can sell an option back to the options market if the current premium is higher than the initial premium paid at the onset. The trader would earn the net difference between the two premiums minus any fees or commissions from the broker.

However, there are times when options are typically exercised early. Deep-in-the-money call options—where the asset’s price is well above the option’s strike price—will usually be exercised early. Puts can also be deep-in-the-money when the price is significantly below the strike price. In most cases, deep prices are those that are more than $10 in-the-money. With lower-priced equities, deep-in-the-money might be characterized as a $5 spread between the strike price and market price.

Early execution can also happen leading up to the date a stock goes ex-dividend—the cutoff date by which shareholders must own the stock to receive the next scheduled dividend payment. Option holders do not receive dividend payments. So, many investors will exercise their options before the ex-dividend date to capture the gains from a profitable position and get paid the dividend.

Advantages and Disadvantages of American Options

American options are helpful since investors don’t have to wait to exercise the option when the asset’s price rises above the strike price. However, American-style options carry a premium—an upfront cost—that investors pay and which must be factored into the overall profitability of the trade.

Examples of an American Option

Say an investor purchased an American-style call option for Apple Inc. (AAPL) in March with an expiration date at the end of December in the same year. The premium is $5 per option contract—one contract is 100 shares ($5 x 100 = $500)—and the strike price on the option is $100. Following the purchase, the stock price rose to $150 per share.

The investor exercises the call option on Apple before expiration buying 100 shares of Apple for $100 per share. In other words, the investor would be long 100 shares of Apple at the $100 strike price. The investor immediately sells the shares for the current market price of $150 and pockets the $50 per share profit. The investor earned $5,000 in total minus the premium of $500 for buying the option and any broker commission.

Let’s say an investor believes shares of Meta Inc. (META), formerly Facebook, will decline in the upcoming months. The investor purchases an American-style July put option in January, which expires in September of the same year. The option premium is $3 per contract (100 x $3 = $300) and the strike price is $150.

Meta’s stock price falls to $90 per share, and the investor exercises the put option and is short 100 shares of Meta at the $150 strike price. The transaction effectively has the investor buying 100 shares of Meta at the current $90 price and immediately selling those shares at the $150 strike price. However, in practice, the net difference is settled, and the investor earns a $60 profit on the option contract, which equates to $6,000 minus the premium of $300 and any broker commissions.

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What Is an American Depositary Share (ADS)?

An American depositary share (ADS) is an equity share of a non-U.S. company that is held by a U.S. depositary bank and is available for purchase by U.S. investors.

The entire issuance of shares by a foreign company is called an American Depositary Receipt (ADR), while the individual shares are referred to as ADSs. But the terms American Depositary Shares and American Depositary Receipts are often used interchangeably.

Understanding American Depositary Shares

An ADR is a negotiable certificate issued by a U.S. bank, under agreement with the foreign company, and is evidence of ownership of ADSs, much the same way a stock certificate denotes ownership of equity shares.

ADSs are meant to facilitate trading of the shares. They can trade over-the-counter (OTC) or on a major exchange such as the New York Stock Exchange (NYSE) or the Nasdaq (Nasdaq), depending on how much the foreign company is willing to comply with U.S. regulations. Listing on a major exchange generally requires the same level of reporting as that done by domestic companies, as well as adherence to Generally Accepted Accounting Principles (GAAP).

The Benefits of ADSs

Foreign companies that choose to offer shares on U.S. exchanges gain the advantage of a wider investor base, which can also lower costs of future capital. For U.S. investors, ADSs offer the opportunity to invest in foreign companies without dealing with currency conversions and other cross-border administrative hoops.

The Downside of ADSs

There is some currency risk involved in holding ADSs. Fluctuations in the exchange rate between the U.S. dollar and the foreign currency will have some effect on the price of shares as well as on any income payments, which must be converted into U.S. dollars.

Tax treatment of dividends from ADSs is also different. Most countries apply a withholding amount on dividends issued for ADRs. This withholding amount can vary. For example, Chile and Switzerland withhold 35% while France can withhold as much as 75% of the tax on dividends, in the case of non-cooperative countries within the EU. The withholding tax is in addition to the dividend tax already levied by U.S. authorities. The dividend tax can be avoided by ADR investors by filling out Form 1116 for foreign tax credit.

Real World Examples of ADSs

A single ADS often represents more than one share of common stock. Further, ADSs can “gap” up or down outside of U.S. trading hours, when trading is happening in the company’s home country and U.S. markets are closed.

For example, South Korea’s Woori Bank, a subsidiary of Woori Financial Group, has ADSs that are traded in the U.S. The bank’s ADS gapped up by $0.03 on July 20, 2016. A technical analysis of the price action on this ADS shows that for the past decade, its price continued higher two-thirds of the time after a gap up.

What Is an American Depositary Receipt (ADR)?

The term American depositary receipt (ADR) refers to a negotiable certificate issued by a U.S. depositary bank representing a specified number of shares—usually one share—of a foreign company’s stock. The ADR trades on U.S. stock markets as any domestic shares would.

ADRs offer U.S. investors a way to purchase stock in overseas companies that would not otherwise be available. Foreign firms also benefit, as ADRs enable them to attract American investors and capital without the hassle and expense of listing on U.S. stock exchanges.

How American Depositary Receipts (ADRs) Work

American depositary receipts are denominated in U.S. dollars. The underlying security is held by a U.S. financial institution, often by an overseas branch. These securities are priced and traded in dollars and cleared through U.S. settlement systems.

In order to begin offering ADRs, a U.S. bank must purchase shares on a foreign exchange. The bank holds the stock as inventory and issues an ADR for domestic trading. ADRs list on either the New York Stock Exchange (NYSE) or the Nasdaq, but they are also sold over-the-counter (OTC).

U.S. banks require that foreign companies provide them with detailed financial information. This requirement makes it easier for American investors to assess a company’s financial health.

Types of American Depositary Receipts

American depositary receipts come in two basic categories:

Sponsored ADRs

A bank issues a sponsored ADR on behalf of the foreign company. The bank and the business enter into a legal arrangement. The foreign company usually pays the costs of issuing an ADR and retains control over it, while the bank handles the transactions with investors. Sponsored ADRs are categorized by what degree the foreign company complies with Securities and Exchange Commission (SEC) regulations and American accounting procedures.

Unsponsored ADRs

A bank also issues an unsponsored ADR. However, this certificate has no direct involvement, participation, or even permission from the foreign company. Theoretically, there could be several unsponsored ADRs for the same foreign company, issued by different U.S. banks. These different offerings may also offer varying dividends. With sponsored programs, there is only one ADR, issued by the bank working with the foreign company.

One primary difference between the two types of ADRs is where they trade. All except the lowest level of sponsored ADRs register with the SEC and trade on major U.S. stock exchanges. Unsponsored ADRs will trade only over the counter. Unsponsored ADRs never include voting rights.

ADR Levels

ADRs are additionally categorized into three levels, depending on the extent to which the foreign company has accessed the U.S. markets.

Level I

This is the most basic type of ADR where foreign companies either don’t qualify or don’t want to have their ADR listed on an exchange. This type of ADR can be used to establish a trading presence but not to raise capital.

Level I ADRs found only on the over-the-counter market have the loosest requirements from the Securities and Exchange Commission (SEC) and they are typically highly speculative. While they are riskier for investors than other types of ADRs, they are an easy and inexpensive way for a foreign company to gauge the level of U.S. investor interest in its securities.

Level II

As with Level I ADRs, Level II ADRs can be used to establish a trading presence on a stock exchange, and they can’t be used to raise capital. Level II ADRs have slightly more requirements from the SEC than do Level I ADRs, but they get higher visibility and trading volume. 

Level III

Level III ADRs are the most prestigious. With these, an issuer floats a public offering of ADRs on a U.S. exchange. They can be used to establish a substantial trading presence in the U.S. financial markets and raise capital for the foreign issuer. Issuers are subject to full reporting with the SEC.

American Depositary Receipt Pricing and Costs

An ADR may represent the underlying shares on a one-for-one basis, a fraction of a share, or multiple shares of the underlying company. The depositary bank will set the ratio of U.S. ADRs per home-country share at a value that they feel will appeal to investors. If an ADR’s value is too high, it may deter some investors. Conversely, if it is too low, investors may think the underlying securities resemble riskier penny stocks.

Because of arbitrage, an ADR’s price closely tracks that of the company’s stock on its home exchange. Remember that arbitrage is buying and selling the same asset at the same time in different markets. This allows traders to profit from any differences in the asset’s listed price. 

ADR Fees

Investing in an ADR may incur additional fees that are not charged for domestic stocks. The depositary bank that holds the underlying stock may charge a fee, known as a custody fee, to cover the cost of creating and issuing an ADR.

This fee will be outlined in the ADR prospectus, and typically ranges from one to three cents per share. The fee will be either deducted from dividends, or passed on to the investor’s brokerage firm.

ADRs and Taxes

Holders of ADRs realize any dividends and capital gains in U.S. dollars. However, dividend payments are net of currency conversion expenses and foreign taxes. Usually, the bank automatically withholds the necessary amount to cover expenses and foreign taxes.

Since this is the practice, American investors would need to seek a credit from the IRS or a refund from the foreign government’s taxing authority to avoid double taxation on any capital gains realized.

Those interested in learning more about ADRs and other financial topics may want to consider enrolling in one of the best investing courses currently available.

Advantages and Disadvantages of American Depositary Receipts

As with any investment, there are distinct advantages and disadvantages of investing in ADRs. We’ve listed some of the main ones below.

Advantages

As noted above, ADRs are just like stocks. This means they trade on a stock exchange or over the counter, making them fairly easy to access and trade. Investors can also easily track their performance by reviewing market data.

Purchasing ADRs is easy because they’re available directly through American brokers. This eliminates the need to go through foreign channels to buy stock in a company in which you may be interested. Since they’re available domestically, shares are denominated in U.S. dollars. But that doesn’t mean you avoid any direct risks associated with fluctuations in currency rates.

One of the most obvious benefits of investing in ADRs is that they provide investors with a way to diversify their portfolios. Investing in international securities allows you to open your investment portfolio up to greater rewards (along with the risks).

Disadvantages

The main problems associated with ADRs are that they may involve double taxation—locally and abroad—and how many companies are listed. Unlike domestic companies, there are a limited number of foreign entities whose ADRs are listed for the public to trade.

As noted above, some ADRs may not comply with SEC regulations. These are called unsponsored ADRs, which have no direct involvement by the company. In fact, some companies may not even provide permission to list their shares this way.

Although investors can avoid any of the direct risks that come with currency exchange, they may incur currency conversion fees when they invest in ADRs. These fees are established in order to directly link the foreign security and the one traded on the domestic market.

History of American Depositary Receipts

Before American depositary receipts were introduced in the 1920s, American investors who wanted shares of a non-U.S. listed company could only do so on international exchanges—an unrealistic option for the average person back then.

While easier in the contemporary digital age, there are still drawbacks to purchasing shares on international exchanges. One particularly daunting roadblock is currency exchange issues. Another important drawback is the regulatory differences between U.S. and foreign exchanges.

Before investing in an internationally traded company, U.S. investors have to familiarize themselves with the different financial authority’s regulations, or they could risk misunderstanding important information, such as the company’s financials. They might also need to set up a foreign account, as not all domestic brokers can trade internationally.

ADRs were developed because of the complexities involved in buying shares in foreign countries and the difficulties associated with trading at different prices and currency values. J.P. Morgan’s (JPM) predecessor firm Guaranty Trust pioneered the ADR concept. In 1927, it created and launched the first ADR, enabling U.S. investors to buy shares of famous British retailer Selfridges and helping the luxury depart store tap into global markets. The ADR was listed on the New York Curb Exchange.

A few years later, in 1931, the bank introduced the first sponsored ADR for British music company Electrical & Musical Industries (also known as EMI), the eventual home of the Beatles. Today, J.P. Morgan and BNY Mellon, another U.S. bank, continue to be actively involved in the ADR markets.

Real-World Example of ADRs

Between 1988 and 2018, German car manufacturer Volkswagen AG traded OTC in the U.S. as a sponsored ADR under the ticker VLKAY. In August 2018, Volkswagen terminated its ADR program. The next day, J.P. Morgan established an unsponsored ADR for Volkswagen, now trading under the ticker VWAGY.

Investors who held the old VLKAY ADRs had the option of cashing out, exchanging the ADRs for actual shares of Volkswagen stock—trading on German exchanges—or exchanging them for the new VWAGY ADRs.

The Bottom Line

American Depositary Receipts, or ADRs, allow Americans to invest in foreign companies. Although these companies do not ordinarily trade on the U.S. stock market, an ADR allows an investor to buy these stocks as easily as they would invest in any domestic stock. The arrangement also benefits foreign firms, allowing them to raise capital from the U.S. market.

Correction—Jan. 24, 2023: A previous version of this article wrongly stated that foreign currency exchange rate fluctuations do not affect the price of ADR and therefore ADR holders avoid any direct risks associated with fluctuations in currency rates. Actually, ADR have exchange rate risk and the price of an ADR is affected by the movements of both the company’s local share price and the national currency rate of exchange against the U.S. dollar.

What Is an Amended Return?

An amended return is a form filed in order to make corrections to a tax return from a previous year. An amended return can correct errors and claim a more advantageous tax status, such as a refund. For example, one might choose to file an amended return in instances of misreported earnings or tax credits. Mathematical errors, however, do not require amendments because the IRS automatically corrects for such errors when processing the tax return.

Who Should File an Amended Return?

All taxpayers are required to file their taxes annually for the previous tax year. Taxpayers may realize that they made a mistake in filling out their tax forms, or their circumstances may have changed after they have submitted or mailed a return that has been accepted by the government. If this occurs, the Internal Revenue Service (IRS) has provided a way for these individuals to redo their taxes by providing an amended return form, Form 1040-X, on the IRS website.

Not all errors need amending by the form. The IRS will spot and correct a mathematical error, for example, when the initial tax return is sent in for processing. When this happens, any refund owed will be adjusted and any extra tax liability due will be billed to the taxpayer. In the event that the individual fails to include a required form or schedule in their submitted original tax return, the IRS will send a letter requesting that they mail the missing information to one of their offices.

When to File an Amended Return

A taxpayer must file an amended return if:

• The taxpayer’s filing status for the tax year changed or was incorrectly entered. For example, if an individual filed as single but actually got married on the last day of the tax year, they will need to amend their return by filing their taxes under the appropriate status—married filing jointly (MFJ) or married filing separately (MFS).
• The number of dependents claimed is inaccurate. An amended return will be necessary if a taxpayer needs to claim additional dependents or remove dependents that were previously claimed. For example, a couple may have included a baby born in January before taxes were filed in April on the prior year’s tax return. That baby cannot be included on the previous year’s tax return because they were not born before the end of the year.
• Tax credits and deductions were claimed incorrectly or were not claimed. In the latter case, the taxpayer may have realized that they qualified for a credit or deduction and may want to file an amended return to reflect this.
• The income reported for the tax year was incorrect. If a taxpayer receives additional tax documents for the tax year (say a Form 1099 or a K-1 arrives in the mail after the tax deadline), they may file an amended tax return to report the additional income.
• Deductibility of certain expenses change as a result of legislation changes. Sometimes, legislation will come through after a taxpayer has filed a return that affects the deductibility of certain expenses. For example, the deduction for private mortgage insurance (PMI) originally expired on Dec. 31, 2017, due to the Tax Cuts and Jobs Act of 2017. The Consolidated Appropriations Act, signed into law in December 2019, extended the deduction through Dec. 31, 2020. This made the deduction available for the 2019 and 2020 tax years and retroactive for the 2018 tax year.
• Tax relief due to a natural disaster changes the taxpayer’s tax liability. This is a common issue for taxpayers who have been affected by a natural disaster, especially one in the later part of the tax year. The government frequently offers tax relief for those affected by natural disasters, but legislation may take longer to finalize than the typical tax season window allows. Taxpayers should pay their full tax liability as it sits when the tax return is due. If legislation changes, an amended return can be filed to reclaim any refund owed to them due to natural disaster tax relief.
• The taxpayer realizes that they owe more taxes than they actually paid. To avoid getting hit with a penalty from the government, they can file an amended return with the IRS.

How to Amend a Tax Return

Form 1040-X has three columns: A, B, and C. Under column A, the figure that was reported in the original or last-amended tax form is recorded. The taxpayer will need to input the adjusted or correct number in column C. The difference between columns A and C is reflected in column B. The adjustments made to a tax return will either result in a tax refund, balance due, or no tax change. The taxpayer also has to explain what changes they are making and the reasons for making each change in a section provided on the back of Form 1040-X.

Disadvantages of an Amended Tax Return

The drawback of filing an amended tax return is that Form 1040-X cannot be submitted electronically for every tax year, although the IRS has recently started accepting e-filed amended returns for tax year 2019. If filling out the form manually, the taxpayer has to mail the printed-out document to the IRS Service Center that processed the original tax form. The IRS manually processes amended returns, and the process can take 16 weeks—or even longer, if the amended return is not signed, is incomplete, has errors, requires additional information, needs clearance by the IRS bankruptcy department, has been routed to another specialized area, or has been affected by identity fraud.

There is, however, a three-year statute of limitations for issuing tax refund checks. Therefore, the taxpayer must file any amended returns that will result in a tax refund within three years after the date they filed the original tax return. An amended return filed to account for additional income or overstated deductions does not fall under any such statute and can be filed at any time.

Download Amended Tax Return Form Here

All current and prior revisions of the IRS Form 1040-X are available on the IRS website here.