Learn about Cliquet options and download a free pricing spreadsheet.
Cliquet options are constructed from consecutive forward start options. Each option is activated once the previous option reaches maturity. At each stage, the strike resets at the current spot price (i.e. the option is at-the-money).
For example, consider a three year Cliquet call option on the DOW with an initial strike of 10000 and annual resets. This is constructed from three one-year calls, each at the money with the entire premium paid in advance. After year one, if the DOW finishes at 12000, then 2000 is paid to the contract holder. The second one-year call starts with a strike of 12000. If the DOW ends the year at 11000, then nothing is paid to the buyer. The final one-year call starts with a strike of 11000.
Alternatively, the investor could just buy three at-the-money calls at the beginning, at the end of year one, and at the end of year two. Unlike a Cliquet option, however, the cost of this strategy is not know in advance. Additionally, Cliquet options are cheaper than purchasing annual calls when volatility is predicted to increase over the option term.
Cliquet options essentially periodically locks in profit at each stage. They provide a minimum and maximum return every year over the contract term, and are attractive because they limit downside risk. Cliquet options are particularly attractive to medium-term passive investors.
This Excel spreadsheet prices American and European Cliquet options using the backwards binomial model developed by Shparber & Resheff (2004).