Bermuda options allow investors to exercise contracts on pre-determined dates prior to expiry. This expeditious exercise function means traders can use the option and convert it to shares on fixed dates.
This Bermuda options 101 trading guide explains how the financial derivative works. We break down trading examples and list their benefits and drawbacks. This review also explores strategies to help beginners get started trading Bermuda options.
Below we list the top-rated brokers that offer retail options trading in 2022.
Bermuda Options Explained
Bermuda options are a hybrid of European and American options which grant traders the right to exercise the contract before the expiration on set dates, usually the same date every month. European options are more restrictive because the contract must be exercised on its fixed expiration date, while American-style options can be exercised any time prior to expiry. As a result, premiums for Bermuda options are usually lower than American-style options.
It is also known as the Mid-Atlantic option because Bermuda lies in between American and Europe. Importantly, Bermuda options are a derivative primarily used on forex, interest rates, bonds, and stocks.
A Bermudan swap option – or swaption – is a spin on a regular swaption which enables the holder to exit a swap before the expiry on predetermined dates. Swaptions are typically traded over the counter and used to speculate on interest rates. Importantly, contract holders aim to manage their exposure to fluctuating interest rates by swapping fixed rates with floating interest rates and vice versa. Swaptions are normally priced using the Monte-Carlo method or the Binomial Tree approach (which can be done in Excel or QuantLib).
How Trading Bermuda Options Works
When an investor purchases a Bermuda option, they have the choice to either exercise the contract on the expiration date, before the expiration date on predetermined dates, or not to exercise it at all. Contract conditions and stipulations vary but there will usually be an early expiration date, which is the minimum date from which the contract can be exercised.
A trader owns stock in Meta Incl (previously Facebook Incl). The trader paid $100 per share and following pressure from US regulators, wants to protect their investment against a fall in the value of the share price.
The investor purchases a Bermuda put option with a one-year expiry and a strike price of $90. The trader pays $5, equivalent to $500 because each option contract equates to 100 shares.
The option contract protects the trader from the share price falling below $90 for the next 12 months. But the early exercise feature of the Bermuda contract means the trader can exercise the option on the fifth day of each month following the first 6 months.
As the investor feared, the share price of Meta Inc falls to $75. The trader exercises the put option on the fifth day of the sixth month. But while the value of the position has fallen and is sold for $75, the strike price of $90 means the investor has made a profit of $15 ($90 strike price – $75 market value).
Now, if the share price has risen dramatically after the option was exercised, the trader would have missed out on the potential returns. So while Bermudas provide early flexibility, there is no guarantee that the decision will be a financially advantageous one.
Pros & Cons Of Trading Bermuda Options
- More flexible than European options affording investors greater control
- Traded over the counter with customization options
- Cheaper premium than American-style options
- Typically used in interest rates and forex
- More expensive than European-style options
- If traders do not exercise the contract until the expiry then a European option would have been cheaper
- The additional exercise dates within a Bermudan option are not necessarily the optimal times to exercise
How successful your trading journey will be will ultimately depend on the strategy you use. Below is a popular example and some key considerations…
This system can be used to hedge against market volatility. Traders can purchase put and call options on the same underlying asset. The potential returns are uncapped and the loss is limited to the premium paid on the options contracts. This could be a good strategy to use when trading Bermuda options if, before the expiration date, you no longer anticipate a significant change in price before the expiry.
Let’s say stock XYZ could be affected by an upcoming election, but the direction of the market price is unknown. The current share price is 60 USD. To use a long straddle options trading strategy, the trader could purchase Bermuda call and put options, both with strike prices at 60 USD, for 2 USD.
- Maximum loss: 4 USD per share is lost only if the stock price remains at 60 USD when the trader chooses to exercise
- Loss: Trader will experience a smaller than 4 USD per share loss if, at the exercise date, the price is between 64 USD and 56 USD
- Profit: If the price is higher than 64 USD or lower than 56 USD at the date of expiration, the investor could generate healthy gains
This approach is arguably better suited to more volatile markets, for example, the NASDAQ in the US or currencies from India or Zimbabwe.
How To Start Trading Bermudan Options
1. Find A Broker
The brokerage you open an account with will have a significant impact on your trading experience. Check contract rules and conditions, alongside premiums and potential payouts. It is also worth considering the market analysis tools and historical data available. The top web platforms provide rich market data with backtesting capabilities.
Longer-term investors may also want to check if there is a free mobile app that can be used to monitor positions on the go. Finally, beginners may want to consider using a demo account to explore a provider’s services before investing real cash.
2. Develop A Strategy
The wrong strategy could serve as a barrier to your trading success. Options trading is risky, so it is important to develop a plan and test it with virtual funds before speculating with real money. Most strategies, whether they be for positions spanning 7 days or 1 year, fall into several buckets:
- Bearish: anticipate that prices will fall
- Bullish: anticipate that prices will rise
- Neutral trading: seeking to benefit from both an increase and decrease in prices
- Volatile trading: seeking to benefit from dramatic price movements in either direction
3. Choose An Asset
There is a modest list of potential markets that Bermuda options can be used on. Look to live price graphs and screeners for insights and signals. You can also analyze historical data and turn to programs like Excel to measure trends and develop profit calculators. The best brokers also provide a range of tools and indicators to help investors monitor volume and volatility, amongst other metrics.
Final Word On Trading Bermuda Options
Bermuda options are a type of exotic options contract that combines European and American-style options. Trading activity with this kind of contract is particularly popular in the USA, UK and Europe. Of course, order spreads, price quotes and request fees vary between brokerages. Speak to your provider’s customer support team if you have questions about margin trading, finance options or registration issues. Alternatively, use our tool kit to start investing in Bermuda options today.
Is Bermuda Options Trading Halal?
Trading options is arguably not seen as permissible in Islam due to the uncertainty, interest charges and similarities to gambling. With that said, answers are speculative, so speak to your local mosque to clarify as it may differ between sects.
Will I Make A Profit From Trading Bermuda Options?
All trading is inherently risky, including Bermuda options. Success will ultimately come down to your strategy and approach to risk management. Also, returns should be considered in the long-term versus short-term peaks and troughs.
Do I Have To Declare Profit Made Through Bermuda Trading?
Trading taxes vary by location. Often, obligations depend on whether activities are considered ‘trading’ or ‘investing’. See our guide to trading taxes for more information. Alternatively, consult a local tax professional.
What Times Can I Trade Bermuda Options?
You can start trading Bermuda options whenever the relevant markets are open. Popular stock exchanges and brokers may also offer after-hours trading.
Where Can I Learn More About Trading Bermudan Options?
Trading Bermuda options does not differ hugely from regular options. See our guide to options trading for more information. Investors can also turn to YouTube explainer videos and forums on Reddit with active traders.