What is Capping?

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  • 08 Dec 2023
What is Capping?

Key Highlights

  • In order to keep it below the option's strike price, capping means actively selling the underlying security of a derivative.
  • If the sale of the underlying is intended to be manipulative, capping is considered to be a violation of securities law. It is lawful to sell legitimately prior to the expiry of an option.

According to the Capping share market definition, selling the asset once the options expire in order to prevent the underlying price from rising is known as capping in the stock market. By keeping the price of the underlying asset or commodity below the strike price, the seller hopes that it will render the options contract void and worthless. This also allows the options writers to take advantage of a premium. Pegging is the opposite of capping in the share market. Here, in order to avoid price drops, a buyer buys large volumes of commodities ahead of the expiry of an option contract.

According to the FINA, any kind of trade manipulation is considered unethical by the self-regulating authority responsible for managing securities markets and exchanges. The capping and piracy practices, where false buying and selling transactions fool investors, are illegal. Moreover, upgrading technology will help regulators detect irregularities in the share market.

When a trader deceives another by making false statements, they are acts of manipulation. With regard to the aspects of securities and licenses, any such misleading acts are prohibited in nature. For instance, Series 9/10 is an entrance test that will enable a person to become the supervisor responsible for the sales of securities.

FINRA is managing this entrance exam, and you will be responsible for all the activities, including corporate securities sales, MMFs, mutual funds, etc., once you have passed it. The practice of capping and pegging is described as illegal. In addition, it is also considered to be illegal to engage in ramp and preplanned options transactions.

The seller and the buyer shall be referred to as call option writers or put option writers. Both practices seek to circumvent the transfer of the commodity to the respective buyer or seller and to obtain the premium paid. The aim is, therefore, to keep the underlying asset price in line with the option strike price.

As far as the buyer option writer is concerned, only if the underlying asset's price is higher than the strike price is the deal worthy. In such cases, the option contract will not have any use, and there will be a loss of premium if the transaction does not meet the criteria. On the other hand, this is precisely what call option writers watch out for to take advantage of the chance to obtain a disadvantage over price manipulations.

The above article delivers all the significant and primary information on capping in the share market. According to the FINRA, all types of illegal activity on the stock exchange are considered securities law violations. Among the less complex trading techniques, capping in the share market is the ideal technique.

FAQs on Capping

Capping is to actively sell the underlying security of the derivative in order to keep it below the strike price of the option. If the selling of the underlying is intended to be manipulative, capping is considered to be a breach of securities law. It is lawful to sell legally before an option expires.

In order to take advantage of the rise in the stock price, the cap price is the value of the asset to be sold before the expiry of the option.

The seller will lose the difference in spot market price and strike price if the stock price is greater than the strike price of the call option. Most option dealers pay high costs in order to compensate for possible losses.

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