What is a Cliquet

A cliquet is cash-settled, exotic option type that periodically settles and then resets its strike price at the level of the underlying at the time of settlement (at-the-money).

Each new option within the cliquet enters into force when the previous option expires. Investors can opt to receive their payout when each option expires or wait until the entire series plays out.

Also known as a "ratchet option."

BREAKING DOWN Cliquet

A cliquet is a series of forward start options, all related to each other. Each forward start option represents the advance purchase of a put or call option with an at-the-money strike price to be determined at a later date, typically when the option becomes active. A forward start option becomes active at a specified date in the future; however, the premium is paid in advance, and the time to expiration and the underlying are established at the time the forward start option is purchased.

If at the first settlement date, the underlying trades below the strike price of the option (for a call) then it expires worthless and resets to the price of the underlying. If at the end of the next settlement, the underlying trades above the new strike, the holder may elect to receive the difference between the market price of the underlying and the strike. Alternatively, the holder can let it ride to receive the sum of all payouts at maturity.

Example

For example, a three-year cliquet option with a strike of 1,000 would expire worthless on the first year if the underlying closes at 900. This value ($900) would then be the new strike price for the following year and should the underlying on the settlement be 1,200, the holder would receive a payout and the strike would reset to this new level. Higher volatility provides better conditions for investors to earn profits.

Think of cliquets as a pre-paid series of at-the-money options where the total premium is calculated and paid in advance.

Similarity to Asian Options

An Asian option is an option type where the payoff depends on the average price of the underlying asset over a certain period of time, as opposed to standard options (American and European) where the payoff depends on the price of the underlying asset at a specific point in time (maturity). These options allow the buyer to purchase (or sell) the underlying asset at the average price instead of the spot price.

Cliquets determine payouts periodically over the life of the options so in a sense they do act as Asian options with an average price. Of course, the math is not the same, especially because there can be payouts of zero along the way as individual forward start options expire worthless.