What Is a CaPut?

A CaPut (or CoP) is a type of exotic option that consists of a call option on a put option. A caput gives the holder the right to purchase a put option at a specified price over a certain time frame. This type of option is known as a "compound option" since it involves an option on an option. A call on a put is also known as a split-fee option.

Other compound options include a call on a call (CaCall), put on a call, and put on a put.

Key Takeaways

  • a CaPut is a compound option involving a call option written on a put option, giving the holder the right to buy a particular put at a set premium, at some point in the future before it expires.
  • A call on a put will involve two strike prices and two expiration dates, one for the call option and the other for the underlying put option
  • The value of a call on a put changes in inverse proportion to the stock price. This means the value decreases as the stock price increases, and increases as the stock price decreases.

Understanding the Caput

CaPuts are composed of two options. The first option is a call option and the second is an underlying put option. Each option will have its own expiration date and strike price. The cost of the caput is based on the combined premiums of the call and put, although only the premium of the call option is paid upfront. The premium for the put option is required if and when the call option is exercised. If the option is exercised the trader takes possession of the put option, and thus pays the premium for that option.

If the CaPut owner exercises the call option, he or she receives the put option, which itself is an option that gives the owner the right but not the obligation to sell a specific asset at a set price within a defined time period. The value of a call on a put, therefore, increases if the underlying price upon which the put is based decreases, and vice-versa. 

Such instruments are used by sophisticated investors and institutions to manage risk or to potentially reduce trading costs. Caput options are only traded over-the-counter (OTC), which means the parties involved in the trade can set their own terms. This may allow for pricing or terms that are more favorable than the vanilla options traded on the exchange. Trading over-the-counter is also a disadvantage. It is not easy to get into a caput trade, since a willing counterparty needs to be found.

Caput Option Example

A trader wants to buy a call option on a put option of XYZ Corp. XYZ Corp stock is currently trading at $30 and the trader believes that price will fall. 

For simplicity, assume the call option premium is $1 and the put option premium is $1. Therefore, the caput costs $2 per underlying share if the call option is exercised. This gives the trade a breakeven price of $28, if the put strike is $30, meaning the stock must drop below $28 in order for the trader to make money. 

If the price of XYZ Corp. stays above $30, and the call is expiring, the trader may opt to not exercise the call since the stock hasn't fallen yet. The trader forfeits the $1 paid for the call but doesn't need to pay the premium for the put option since they opted not to buy it. 

If the price of XYZ Corp. does fall below $30, then the call option may be exercised at the discretion of the holder. This would incur the additional premium of buying the put. The profit on the trade then depends on where the price of XYZ Corp. goes. If the price falls to $24 at the put's expiration, the trader makes $4 per share. They can sell the shares at $30 using the put, buy the shares back on the open market at $24 ($6 profit), but they paid $2 per share in premiums.