The price that is charged by the seller of a cap in return for giving the cap buyer the right to exercise on some underlying price or rate. In other words, caps are typically purchased for a price (known as the premium) paid by the buyer against the seller guaranteeing that the underlying rate will not exceed a preset level over a specific period of time (the cap’s lifespan). Brokers and counterparties quote cap premiums for interested buyers (such as investors, hedgers, etc). Cap premiums are typically expressed as a percentage of the notional principal amount of a given contract

The size of a cap premium is determined by a number of factors including: the duration of protection, the relationship of the cap level with the current and expected levels of interest rates (generally, the lower the cap rate, the higher the cap premium and vice versa), and volatility of interest rates (the more volatile interest rates are, the higher the cap premium).

A cap premium is similar to an call option premium as both represents the price the seller (short) quote and charge against conferring on the buyer (long) the right to exercise on an underlying variable.