  This paper examines the valuation of American capped call options with
two-level caps. The structure of the immediate exercise region is significantly
more complex than in the classical case with constant cap. When the cap grows
over time, making extensive use of probabilistic arguments and local time, we
show that the exercise region can be the union of two disconnected set.
Alternatively, it can consist of two sets connected by a line. The problem then
reduces to the characterization of the upper boundary of the first set, which
is shown to satisfy a recursive integral equation. When the cap decreases over
time, the boundary of the exercise region has piecewise constant segments
alternating with non-increasing segments. General representation formulas for
the option price, involving the exercise boundaries and the local time of the
underlying price process, are derived. An efficient algorithm is developed and
numerical results are provided.
