DEFINITION of 'Caplet'
A European interest call option that sets a maximum future interest rate for an interest rate derivative. A caplet is analyzed as a call option, with the duration of the option typically set to coincide with interest rate payment dates. A series of caplets is called a cap, and holders typically purchase a cap to cover backtoback time periods.
BREAKING DOWN 'Caplet'
Caplets are used by investors to hedge against the risk associated with floating interest rate financial products, though investors are more likely to invest in a cap rather than single caplets. Caplet holders must decide whether to exercise the option or let it expire when each interest rate payment day is met. If the rate locked in by the caplet is greater than the strike rate at expiry, then the option pays the difference of the two rates multiplied by a factor. A caplet that is purchased before an increase in market yield will be inthemoney upon expiry, and a caplet that is sold will be inthemoney if the market yield declines.
Returns on a caplet are calculated as:
(interest rate – caplet rate) x principal x (# of days to maturity/360)
For example, take an investor who has purchased a 2year cap that references the 3month LIBOR rate. This investment is composed of seven caplets, and each caplet lasts three months. The price of the cap is the sum of the price of each of the seven caplets.

Interest Rate Call Option
An interest rate derivative in which the holder has the right ... 
Brace Gatarek Musiela Model  BGM
A nonlinear financial model that uses LIBOR rates to price interest ... 
Life Cap
The maximum amount that the interest rate on an adjustable rate ... 
Capped Option
A security that features a maximum limit on the holder's profit ... 
InterestRate Derivative
A financial instrument based on an underlying financial security ... 
Interest Rate Cap Structure
Limits to the interest rate on an adjustablerate loan  frequently ...

Managing Wealth
Managing Interest Rate Risk
Learn which tools you need to manage the risk that comes with changing rates. 
Trading
How & Why Interest Rates Affect Options
The Fed is expected to change interest rates soon. We explain how a change in interest rates impacts option valuations. 
Trading
Managing Interest Rate Risk
Interest rate risk stems from the possibility that an interestbearing assetâs value will change due to changing interest rates. 
Trading
Three Ways to Profit Using Call Options
A brief overview of how to provide from using call options in your portfolio. 
Trading
The Basics of Options Profitability
The adage "know thyself"and thy risk tolerance, thy underlying, and thy marketsapplies to options trading if you want it to do it profitably. 
Trading
Options Hazards That Can Bruise Your Portfolio
Learn the top three risks and how they can affect you on either side of an options trade. 
Trading
Exploring The World Of Exotic Options
Exotic options provide investors with new alternatives to manage their portfolio risks and speculate on various market opportunities. The pricing for such instruments is considerably complex, ... 
Trading
Sensitivity Analysis For BlackScholes Pricing Model
Trading options requires complex calculations, based on multiple parameters. Which factors impact option prices the most?

How are call options priced?
Learn how aspects of an underlying security such as stock price and potential for fluctuations in that price, affect the ... Read Answer >> 
How can an investor reduce interest rate risk?
Learn about the different ways investors can reduce interest rate risk. Locking in interest rates increases certainty for ... Read Answer >> 
How do I change my strike price once the trade has been placed already?
Learn how the strike prices for call and put options work, and understand how different types of options can be exercised ... Read Answer >> 
What does it mean to be long or short a derivative?
Find out more about derivative securities and what it indicates when traders or investors establish a long or short position ... Read Answer >> 
How can derivatives be used to earn income?
Learn how option selling strategies can be used to collect premium amounts as income, and understand how selling covered ... Read Answer >> 
What does high open interest tell you about an option?
Learn about the open interest of options contracts and what a high and a low open interest indicate about the liquidity of ... Read Answer >>