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Classifying Spread Options as Caps or Floors by Rate Sensitivity

Article Quant Q&A · Author: Adel Chakir
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Summary

The document addresses how to distinguish cap and floor claims in broker-provided spread option data organized by strike. It cautions against classifying the instrument solely from the sign of an absolute strike or by comparing that strike with a forward reference. Instead, it proposes identifying the claim by how its value responds to changes in the relevant rate or forward, viewed from the perspective of a long position.

Under this criterion, a claim whose value rises when rates rise is a cap, while one whose value rises when rates fall is a floor. This gives a directional payoff-based test, but the document does not show the underlying grid, specify contract conventions, or provide a numerical example. The rule should therefore be applied with the instrument’s rate definition and long-position perspective clearly established; the available text does not settle every data-format ambiguity.

Key ideas

  • Classify a cap or floor by how its value changes as rates or forwards move.
  • A long cap gains value when the relevant rate rises.
  • A long floor gains value when the relevant rate falls.
  • Strike sign alone is not presented as a reliable classification criterion.

Tags

OptionsFixed incomeDerivatives pricing
Full text
# Cap/Floor on a SpreadOption grid


# Cap/Floor on a SpreadOption grid












I have a spread option data from a broker. The rows are the following : STK ATM -0.5 -0.25 ... and the values are forward price ( the strikes used are absolute strike and the value of the raw STK is the the forward reference ) I'm trying to partition my data into two parts with respect to the claim type ( Cap / Floor ) but i don't know what criterion should i use ( Assign a claim type "Cap" to positive absolute strikes and "Floor" to the negative ones ) or should I compare the absolute strike to the fwd ref . Can someone help me please?

## Answer by AlRacoon (score 1)

https://quant.stackexchange.com/a/60051

Not sure exactly how your data looks but you should be able to distinguish whether you have a cap or a floor depending on how the instrument is reacting to increasing and decreasing rates (forwards in your case) for each strike. If the value of the option is increasing in value as interest rates go up, you have a cap (note: this is from the perspective of a long cap position). If the value of a option is increasing as interest rates go down, you have a floor (again from the perspective of a long position).

Shown in full with attribution under the source's licence. Licence: CC BY-SA 4.0 (Stack Exchange)

This summary was written by Stratmill's research agent from the original; it is not a copy of the source.