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A cliquet (also called a ratchet option) is a series of forward-start options. At each period, the return of the underlying is measured, then capped and/or floored. The final payoff is the sum (or average) of these clipped periodic returns. Cliquets are common in insurance-linked products and guaranteed investment contracts.
Consider a 5-year annual cliquet on the Euro Stoxx 50 with a local floor of 0% and a local cap of 8%. Each year, the index return is measured. If the index returns +15% in year 1, the investor gets 8% (capped). If it returns −10% in year 2, the investor gets 0% (floored). If it returns +5% in year 3, the investor gets 5% (within the corridor). The final payoff is the sum of all five clipped returns.
LFLC (Local Floor, Local Cap): each period's return has both a floor and a cap. The most common variant. LFGC (Local Floor, Global Cap): individual periods are floored, but the total sum is capped. Cheaper than LFLC because the global cap limits the maximum payout. Reverse Cliquet: starts with a fixed coupon and subtracts floored periodic losses. The investor receives Coupon − Sum(losses). Profitable if markets are calm.
Each period of a cliquet is essentially a forward-start option. The price depends on the implied volatility for each future period — the forward volatility surface. A cliquet is not just sensitive to current implied vol; it is sensitive to the term structure and the volatility of volatility. This makes cliquets among the most model-dependent structured products to price.
Insurance companies and pension funds use cliquets to offer equity-linked returns with downside protection to policyholders. The local floor guarantees no loss in any single period, while the cap limits the cost. The insurer hedges with the cliquet; the policyholder gets a structured equity exposure with built-in guardrails.
A cliquet is a series of options that measure the return of an underlying asset over multiple periods. Each period return is capped at a maximum and floored at a minimum. The final payoff is the sum of all these clipped returns. It allows investors to participate in equity upside with built-in limits on both gains and losses per period.
LFLC (Local Floor, Local Cap) applies a floor and cap to each individual period return. The total payoff is the uncapped sum of clipped returns. LFGC (Local Floor, Global Cap) floors each period but caps the total sum at a maximum. LFGC is cheaper because the global cap limits the issuer maximum payout, reducing the cost of the embedded options.
Because each period is a forward-start option whose value depends on the implied volatility at a future date, not today. Pricing requires modeling the forward volatility surface and the volatility of volatility. Small changes in forward vol assumptions can significantly shift the price. Cliquets are among the most model-dependent products in structured finance.
FinLingo covers cliquets in Level 4 (7 units on forward-start and cliquet options). Build LFLC, LFGC, and reverse variants in The Lab. Level 1 is free.
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