Bermudan Option
Quick Definition
An option that can be exercised on specific predetermined dates before expiration, falling between American and European exercise styles.
What Is Bermudan Option?
A Bermudan option (named because Bermuda is geographically between America and Europe) allows the holder to exercise on a set of specific dates during the option life, rather than any day (American) or only at expiration (European). Common exercise dates might be monthly or quarterly. Bermudan options are frequently found in interest rate markets, particularly in callable bonds and swaptions, where the issuer can call or exercise on coupon dates. They are priced between American and European options — more expensive than European (due to added flexibility) but typically cheaper than American options. Bermudan options are commonly valued using lattice models or Monte Carlo simulation with early exercise features.
Bermudan Option Example
- 1A Bermudan swaption allows the holder to enter into an interest rate swap on any quarterly date over the next 5 years, but not on any other day
- 2A callable bond with semi-annual call dates is essentially embedding a Bermudan call option — the issuer can redeem on each coupon payment date
Related Terms
American Option
An option contract that can be exercised at any time before or on the expiration date, providing maximum flexibility to the holder.
European Option
An option contract that can only be exercised at expiration, not before, typically found in index options and OTC markets.
Early Exercise
The act of exercising an American-style option before its expiration date, typically done only when specific conditions make it financially advantageous.
Exercise Price
The predetermined price at which an option holder can buy (call) or sell (put) the underlying asset, also known as the strike price.
Call Option
A contract giving the holder the right, but not the obligation, to buy an underlying asset at a specified price within a specified time period.
Put Option
A contract giving the holder the right, but not the obligation, to sell an underlying asset at a specified price within a specified time period.
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