Five drivers: (1) SOFR forward curve level at the cap 's term; (2) implied SOFR volatility (higher vol = higher time value); (3) cap term (longer = more expensive); (4) strike (a lower strike costs more); (5) notional. In 2026, implied volatility remains elevated versus the post-2010 average, caps are relatively expensive.
How each driver moves cap premium
SOFR forward curve: cap pricing is fundamentally a function of the market's expected path for SOFR. When the forward curve steepens (longer-dated SOFR rises relative to spot), caps that pay against longer-term SOFR levels rise in premium. The Fed's policy path drives the forward curve; SOFR forwards reprice on every Fed meeting and major employment release.
Implied volatility: caps are options, and option premiums scale with implied volatility. Implied SOFR vol rose materially during the 2022-2023 tightening cycle and remains elevated relative to the calmer 2010s. Higher implied vol means caps cost more even if the forward curve is unchanged.
Term and strike: a 3-year cap costs roughly 1.6x to 2.0x a 2-year cap on the same notional and strike, because the longer term gives the cap more chances to be in the money. A lower strike costs more. An at-the-money cap costs more than a deep out-of-the-money cap and less than an in-the-money cap.
Notional and amortization: a flat-notional cap costs more than an amortizing-notional cap on a loan with declining balance, because the cap continues to provide protection even as the loan paydowns. Match cap notional to the loan's expected balance schedule for cost efficiency.
Sources
- Secured Overnight Financing Rate (SOFR) · Federal Reserve Bank of New York · daily
- Treasury Constant Maturity Series (DGS5, DGS10) · Federal Reserve Bank of St. Louis (FRED) · weekly
- Financial Stability Report · Board of Governors of the Federal Reserve System · 2025-11