Monday, June 17th, 2019

Trading Bermuda Style Options

 

An options style that falls halfway between American style stock options and European style stock options is trading Bermuda style options. Trading Bermuda style options happens with stocks, futures, and, especially, interest rate swaps. How does it fit “halfway” between the other two styles? One can execute American style stock options at any time during the contract period of the option. One can only execute a European style contract at expiration. When trading Bermuda style options, an options buyer has a number of specific dates on which he can execute the contract up to and including at expiration of the contract.

Buying and Selling Puts and Calls when Trading Bermuda Style Options

Aside from the issue of when one can execute the contract, trading Bermuda style options works like other options trading. Traders can either buy or sell an options contract. Contracts are either puts or calls. A put gives the buyer the right to execute the contract and sell the equity underlying the contract. A call gives the buyer the right to execute the contract and buy the equity underlying the contract. In each case the seller of the options contract is obligated to buy in the case of a put and sell in the case of a call depending on the wishes of the buyer. The seller is paid to take this risk. The value of an options contract is based on the fact that the contract specifies the price at which the underlying equity will be bought or sold if the buyer so chooses. If a buyer of a call contract buys an $80 call on a stock that currently trades for $80 he will pay very little. This is because if he turns right around and executes the contract and then sells the stock he will not make any money. If the price of the underlying stock goes up, the buyer may want to execute the contract in order to cash in on his gains, fearing that the stock might fall again. With an American style options contract this is always possible. With a European style contract it is not possible until expiration. However, when trading Bermuda style options, there will be a set of dates prior to expiration on which the trader can execute in order in order to pocket his profits. Likewise with puts, the trader can take advantage of a fall in stock price and execute on a date specified by the options contract when trading Bermuda style options.

Contract Value when Trading Bermuda Style Options

Options buyers try to pick the most advantageous times for execution of options trades. The value of the options contract depends on the price specified in the contract and on the current market price of the underlying. It also depends on the amount of time remaining until expiration. This is called the time value of the contract. When the market believes that a stock may well move up in price this time value may be substantial in bringing up the value of an options contract. Taking advantage of market sentiment as regards time value when trading Bermuda style options lies halfway between the situation for American and European style, better than European and worse than American. With these basic options trading facts in mind be aware of the differences when trading Bermuda style options instead of American or European.

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