Bermudan option
Also written Bermuda option · Bermudan-style option · Bermudan options
An option that can be exercised only on specific dates named in the contract, usually near expiry — more flexible than a European option, less flexible than an American one.
In plain language
Options differ in when the buyer may use the right. Using it is called exercise. The workbook gives three types:
- European — only on the expiration date.
- American — any day on or before the expiration date.
- Bermudan — only on set days before expiration. The contract names those days.
The Bermudan sits between the other two. Its set dates are usually close to the expiration date. So a Bermudan option gives a trader more freedom to exercise than a European option, but less than an American one.
How it works
Exercise is the event that matters. To exercise, in the workbook's words, is "to put into effect the right to buy or sell the underlying security that is specified in the options contract" — and before doing so, the holder has to know what type of option he has and whether he is allowed to.
| Style | When the buyer may exercise | Flexibility |
|---|---|---|
| European | Only on the expiration date | Lowest |
| Bermudan | Only on specified dates, usually near expiry | Between the two |
| American | Any trading day on or before expiry | Highest |
Exercise is not the only exit. The workbook adds a point about exchange traded options that applies to any style: participants can sell their option in the secondary market prior to expiration to square off, even if they cannot exercise it yet.
In India's exchange traded market the contract specification for interest rate options is premium style European call and put options, cash settled — so Bermudan exercise is not a feature of the exchange contract.
A worked example
Illustrative contracts and prices, using the workbook's bond and lot size. The three styles are compared as a teaching device.
Three traders each hold a call on 6.10% GOI 2031 at a strike of Rs 98.50, one lot of 2,000 units, expiring on 30 June. The only difference is the exercise style. The Bermudan contract names 28 April, 28 May and 30 June as exercise dates.
The bond's price path:
| Date | Bond price | Intrinsic value per lot |
|---|---|---|
| 15 May | Rs 99.60 | (99.60 − 98.50) × 2,000 = Rs 2,200 |
| 28 May | Rs 99.40 | (99.40 − 98.50) × 2,000 = Rs 1,800 |
| 30 June | Rs 98.30 | 0 — out of the money |
| Holder | What he could do by exercising |
|---|---|
| American | Exercise on 15 May and capture Rs 2,200 |
| Bermudan | Not on 15 May; exercise on 28 May for Rs 1,800 |
| European | Only on 30 June, when the call is worth nothing |
(Premium paid is ignored, since it is the same sunk cost for all three.)
The Bermudan holder did not get the best day, but he got a day. If the European call was exchange traded, its holder could still have sold the option in May rather than exercised it — which is why the workbook reminds candidates that selling in the secondary market is always a route out of a traded option.
Why NISM asks about it
Chapter 4 (Exchange Traded Interest Rate Options), section 4.3 on the style of options, defines European, American and Bermudan options in turn, and the contract specification in the same chapter fixes Indian exchange traded interest rate options as premium style European calls and puts. Expect a classification question — which style may be exercised only on specific dates before expiry — and a question on which style the Indian exchange contract uses.
Common exam traps
- Bermudan = specific dates named in the contract, usually near expiry. Not "any day" (American) and not "only on expiry" (European).
- It sits between American and European in flexibility — the workbook's own framing.
- Indian exchange traded interest rate options are European, premium style, cash settled. Do not describe them as Bermudan or American.
- Being unable to exercise is not being unable to exit. A traded option can be sold before expiry to square off.
- Exercising means putting into effect the right to buy or sell the underlying — it is the buyer's choice, not the seller's.
Where this is taught
Free preparation for NISM Series IVRelated terms
- American optionAn option whose holder may exercise it at any time on or before expiry. All exchange-traded index and stock options in India are European style instead — exercisable only on expiry.
- Call optionA contract giving its buyer the right, but never the obligation, to buy the underlying at a fixed strike price — so the loss is capped at the premium and the gain is not.
- OptionA contract giving the buyer the right, but not the obligation, to buy or sell the underlying at a stated price on or before a stated date, in exchange for a premium paid to the writer.
- European optionAn option that can be exercised only on its expiry date. Indian equity options are European — coded CE for calls and PE for puts — unlike American options, exercisable any time up to expiry.
- ExercisePutting an option's right into effect: a call holder buys the underlying at the strike, a put holder sells at the strike. In cash settled IRD options the holder simply receives the difference.
- Premium style optionThe style in which Exchange Traded Interest Rate Options are structured: the buyer pays the full option premium upfront, in cash, to the seller, at the time of the trade.
- Put optionA contract giving its buyer the right, but never the obligation, to sell the underlying at a fixed strike price — insurance against a fall, bought for a premium.