Bermudian Option

Bermuda Options

Bermuda option is a type of option that can only be exercised on predetermined dates, e.g. at 1st of each month. It falls somewhere between European option (which can be exercised only at maturity) and American option (which can be exercised at any point chosen by the holder). Like the other exotic options, it is traded over-the-counter.

An example of a Bermudan Option is a bond option that can be exercised only on coupon payment dates.[1] For example, a corporation may issue a five-year callable bond with a refunding provision. This issue can be called on any coupon date (limited exercise dates) and replaced with a new issue at a lower rate.[2]

As the Bermuda option ‘lies’ between American and European options, its premium should also fall between those of American and European options, i.e. European premium < Bermudan premium < American premium.

Bermuda swaptions are used as well.

Alternative explanation:
In addition to an expiration date, Bermuda options have an "early exercise" date. Before the early exercise date, the option behaves like a European-style option in that it cannot be exercised. After the "early exercise" date, the option behaves like an American-style option, exercisable at any time up until expiration. A common example of this type of option is an employee stock option where the option holder must possess the option for a certain period (the vesting period) before the option can be exercised.[3]

Sources:
[1] Hull C., John; Options, futures & other derivatives, Prentice-Hall International, Inc., Upper Saddle River, 2000
[2] Smith, Clifford W.; Managing financial risk, Harper & Row, Ballinger Division, New York, 1989
[3] http://www.fintools.com/doc/options/optionsGlossary.html
[4] http://www.anz.com/edna/dictionary.asp?action=content&content=bermuda_option
[5] http://www.investopedia.com/terms/b/bermuda.asp

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