What are Bermuda Options?
June 15, 2021 | AtoZ Markets – Bermuda options are contracts with exotic options used on predetermined fixed dates after lock-in periods finish. Usually, these dates are one day per month. In short, holders can use the options on specific dates throughout the option’s life.
Options are derivatives. They came from assets like shares or stocks. Option holders can do asset transactions at a specific price called strike price during or before a chosen date.
If an individual buys an asset, we call that a call option. On the other hand, if the individual decides to sell the asset, we call that a put option. Exercising is the convertibility of these contracts into shares at a predetermined price.
Bermuda options term history
Bermuda’s location is in the Atlantic Ocean, approximately 1030 km from the east coast of America. It lies between two places, thus having the name Bermuda option or Mid-Atlantic option. It is a combination of two or more exotic options — the American and the European option.
The American option, European option, and the Bermuda option
For American option holders, there is no restriction with the exercise dates. It can be at any convenient time.
On the other hand, for European option holders, the exercise date can only be on the maturity or expiration date.
Bermuda options are more expensive than the European option and are cheaper than the American option. Bermuda option holders can buy and sell securities or assets at a predetermined price on specific dates and expiration dates.
An example of a Bermuda option
Let’s say Company A decided to buy Company B’s share for $2000 per share on February 1, 2020. Company A bought 1,000 shares from Company B with a total amount of $2 million. To be safe, Company A also bought a Bermuda option that expires in six months or August 1, 2020, with an option to exercise on the first day of every month. This Bermuda option protects Company A from possible price declines.
Advantages and disadvantages of Bermuda options
Let us list down the advantages that Bermuda option holders have.
- Price. They are cheaper than American options.
- Exercise options. They have better exercise options than European options.
- Trading. The tradings are over-the-counter products. Unlike standard options with standard trades, Bermuda holders can have customized trades.
- Usage. Bermuda options are typical in forex markets and interest rate contracts.
- Receiving method. It is a better decision for companies receiving foreign currency as payments with prefixed date options. The payment premium is less if compared to American options.
On top of all the advantages, holders should also weigh in disadvantages. Listed below are several disadvantages of Bermuda options.
- Exercise dates. Holders can only exercise them on predetermined specific dates. Also, the Bermuda option writers have more control over exercise dates than the option buyer.
- Price. Albeit being cheaper than American options, they are more expensive than European options. If a company wants to exercise on the expiry, they might be better off with European options.
- Pricing models. The pricing model is more complicated. The standard pricing model, which is Black Scholes, cannot do the undertaking.