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Trading Capped Style Options
Trading capped style options provides options sellers with a limit to their downside risk while putting a cap on potential profits for a seller. In theory, one can engage in trading either American style options or European style options while trading capped style options. Capped style options act like a circuit breaker while not necessarily interfering with the ability of a trader to execute a contract at a time of his or her own choosing. When trading capped style options, there is a profit cap as part of the options contract. Let us say that price of the underlying rises to a given point in a call option contract. The contract is automatically exercised by the terms of the contract. If that contract is for a put and the price drops to a predetermined price the contract is also exercised. How does trading capped style options affect the trader?
Less Price Volatility Leads to Lower Contract Prices
Writing options is commonly more profitable over the long run than buying options. This is because sellers set prices and only sell when the odds of profit are strongly in their favor. However, there is always a risk of significant loss in writing options because the seller of an options contract is obliged to comply with the terms of the contract no matter how badly he fares in the trade. Trading capped style options reduces the risk of loss for the seller of an options contract and, as such, reduces the price needed to purchase an options contract. The basic options trading tools are the same for capped style options as they are for other types of options. And, the cap on an options contract must be factored in to the equation for both fundamental and technical analysis. To the extent that an options trader can get into trades at a lower price and reliably gain a reasonable profit, trading capped style options can be profitable as it increases his leverage on the vast majority of options trades.