What is a Cliquet?

A cliquet, also called a "ratchet option," is a series of at-the-money (ATM) options, either puts or calls, where each successive option becomes active when the previous one expires.

Key Takeaways

  • A cliquet, also called a "ratchet option," is a series of at-the-money (ATM) options, either puts or calls, where each successive option becomes active when the previous one expires.
  • The total premium and the exact reset dates are known at the time of transacting a cliquet.
  • Cliquet holders can opt to receive their payout when each option expires or wait until the entire series plays out to receive the sum of all payouts at maturity.

Understanding a Cliquet

A cliquet is cash-settled, exotic option type that settles at predetermined dates and then resets its strike price based on the price of the underlying security at the time of settlement. Each new option within the cliquet enters into force when the previous option expires. The total premium and the exact reset dates are known at the time of transacting a cliquet. Investors can opt to receive their payout when each option expires or wait until the entire series plays out.

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 (ATM) 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. The premium is paid in advance, while the time to expiration and the underlying security are established at the time the forward start option is purchased.

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

The main advantage of initiating a cliquet is, if an investor expects volatility to rise, they can lock in their profits at predetermined levels and thus maximize their overall portfolio return.

Cliquet 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.

Cliquet Similar 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 since there can be payouts of zero along the way as individual forward start options expire worthless.