The right-back's current deal was due to finish at the end of June 2017.
But after talks with manager Gianfranco Zola, it was agreed that a parting of the ways was in everyone's interests and the Club was happy to help Caddis get fixed up elsewhere by allowing him to become a free agent.
Blues have brought in Emilio Nsue from Middlesbrough during this transfer window as a major signing and Josh Dacres-Cogley moved up ahead of Caddis in the pecking order for right-back this season.
As Jonathan Spector has also left Blues on a free, for Orlando City in the MLS, it means that Zola's rebuilding of the Blues continues to gather apace - Spector, then Caddis, were Blues' longest-serving players.
Caddis, 28, joined Blues for a second time in August 2013 from Swindon Town, having previously spent a successful loan spell at St. Andrew's the previous season.
During his most recent spell at Blues, Caddis made a total of 131 First Team appearances.
However, he has barely figured this season, with his solitary appearance coming in the 1-0 home defeat to Oxford United in the EFL Cup back in August.
He was also sidelined for several months following surgery on a dislocated shoulder, which he has subsequently recovered from.
The popular Scot also scored 16 times for Blues, the most famous of which came during the dramatic final day of the 2013/14 campaign when he nodded the stoppage-time equaliser in the 2-2 away draw at Bolton Wanderers that kept Blues in the Championship.
The Club wishes Paul all the very best for the future and would like to thank him for his service to Blues over the past three-and-a-half years.