DEFINITION of 'Capped Option'

A security that features a maximum limit on the holder's profit potential. A capped option is automatically exercised if and/or when the underlying asset reaches a certain price. Obviously, a put option would be exercised if the price on the underlying asset falls below the option cap price, while a call option would be exercised if the underlying asset price rises above the option cap price, thereby locking in the maximum profit possible from the option exercise.

BREAKING DOWN 'Capped Option'

While capped options protect the writer from losing more than a predetermined, fixed amount and, hence, would seem to be disadvantageous to buyers, they are generally easier to exercise and often don't require the type of movement that one would need to see in a standard option to realize decent profits. Some examples of capped options include options on the S&P 100 and S&P 500 indices that were created by the Chicago Board of Options Exchange (CBOE) in 1991.

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