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What is a capped call?

A capped call (or capped option) is an option that automatically sells a stock if the price goes beyond or below some predetermined price. A capped call caps your gains but is cheaper than a normal option.

An example where you would use a capped call

Let’s take an example:

  • Company Name: Apple
  • Expected Price Increase: 10%
  • Capped Call Sell Price: 10% increase
  • Price Of Capped Call: $500
  • Price Of Normal Put Option: $5,000

When you buy a stock, you typically hope for its stock price to increase significantly. But what if you only expect the stock price to increase modestly, say 10%?

Say that you expect Apple’s stock price to increase by 10%. You don’t have to spend $5,000 to buy an expensive put option or the stock itself. Instead, you might only want to purchase some option that automatically sells if the stock price increases beyond a certain amount. With capped calls, you would be able to get the same 10% gains (if you’re right) at only $500 instead of $5,000.

If the stock price of Apple were to increase by 50% instead, you would have lost out on the 40% increase because your capped call was automatically exercised at the 10% limit. Obviously, the cheaper cost (i.e. less risk) comes at the price of missing out unexpected gains.

above some predetermined price.