Atlantic Spread

In options trading, there's a type of option called a European Option and another type called an American Option. (There's no African or Asian options...imperialism much?)
A European Option can only be exercised on its expiration date. Meanwhile, an American Option can be excised any time prior to its expiration (because we fought a revolution to win just that kind of freedom - USA! USA! - that and we're really passionate about tax-free tea).
An Atlantic Spread is an option strategy that involves buying both a European option and an American option for the same underlying asset.
Get the name? Atlantic Spread? Like the ocean? Because it's an American option and a European option - places on opposite side of the Atlantic Ocean...who says options traders aren't clever? As an aside, if there was such a thing as an African option, then a combo strategy involving a European option and an African option would be a Mediterranean Spread. As it is, Kraft has a number of fine recipes for creamy mediterranean spreads.
Anyway, in an Atlantic spread, a trader will use the American and European options for opposite sides of the trade. So, the trader might go long with an American option and short with a European one, with all the other aspects of the options remaining identical (like the underlying asset, the expiration date, the strike price, etc.). This setup could also be reversed, with the American option short and the European option long.
In general, the long and short positions should cancel each other out. The trader is basically betting on both sides simultaneously, like taking both competing teams in a sports bet. If the trader holds both to maturity, the position is a wash, minus whatever the options cost.
However, since the European option is less flexible, it is also less valuable, meaning it should be cheaper to buy than the American option. Meanwhile, the American option can be exercised at any time.
The strategy basically becomes a bet on the American option, which can get cashed in if the market goes the right way at any time between now and the expiration date. However, if the market turns against the bet, the European option works as a hedge. And since the European option is cheaper, the hedge gets purchased at a discounted price compared to the price of the main bet.



Find other enlightening terms in Shmoop Finance Genius Bar(f)