Difference Between Cap And Floor Option

Interest rate floors are utilized in derivative.

Difference between cap and floor option.

An interest rate floor is an agreed upon rate in the lower range of rates associated with a floating rate loan product. Like other options the buyer will pay a premium to purchase the option so the buyer faces credit risk. An interest rate cap is a derivative in which the buyer receives payments at the end of each period in which the interest rate exceeds the agreed strike price an example of a cap would be an agreement to receive a payment for each month the libor rate exceeds 2 5. Broadly speaking a swaption is similar to a a cap or a floor in that it consists of a series of options.

Payoff rule for a typical cap each payment date the cap pays the difference if positive between a floating index rate and the cap rate. While this boundary limits the profit potential for the holder it comes at a reduced cost. Caps and floors are based on interest rates and have multiple settlement dates a single data cap is a caplet and a single date floor is a floorlet. Caps are either offered over the counter by dealers or embedded in a security.

This creates a gap between the volatilities of caps and swaptions which in turn provides an opportunity for investors to take views on future correlations and accordingly execute their trades. Cap rate or strike rate.