Definition of Capped Style Option
A capped style option is designed to limit the amount of profit that an options trader can earn. Since this style of option limits or puts a cap on the profit, it is known as a capped style option.
The basic idea of a capped style option is to automatically exercise an option contract once the underlying asset like shares or commodities reaches a predetermined price level. This is how capped style options work for calls & puts:
- Capped call option: option is automatically exercised once the underlying asset closes at or above a preset price level
- Capped put option: option is automatically exercised once the underlying asset closes at or below a preset price level
Traders arrive at the cap price for a capped style option by:
- Adding a cap interval to an option’s strike price (call option)
- Subtracting the cap interval from an option’s strike price (put option)
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