A Bermudan option is an exotic type of options contract that allows the holder to exercise the option at certain predetermined dates. The name “Bermudan” comes from the fact that this type of option was first introduced in Bermuda.
The key feature of a Bermudan option is that it gives the holder the flexibility to choose when to exercise the option. This is in contrast to European-style options, which can only be exercised on the expiration date.
The holder of a Bermudan option will pay a premium upfront for this flexibility. Whether or not this is a good deal depends on the expected future path of the underlying asset’s price. If the price is expected to rise, then it may be worth paying the premium for the ability to exercise early. On the other hand, if the price is expected to fall, then it may be better to wait and see if the option expires in-the-money.
Bermudan options are often used in finance as a way to hedge against certain types of risk. For example, a company that is exposed to currency risk may purchase a Bermudan option on a foreign currency in order to protect itself from potential losses.