Kapoor, 2008, "Optimal Dynamic Hedging of Cliquets," Working Paper.
Generally speaking, cliquet options are appealing to investors because they inherit, at least partially, the very attractive payoff of lookback options, while rendering it both more affordable and more flexible, thanks to the decrease in the updating frequency of the running extremum of the underlying asset price, as well as to the possible partial and non uniform spanning of the option life.
However, cliquet options raise a number of pricing and hedging issues.
In Section II, the specific properties of cliquet options are highlighted, in comparison with alternative contracts traded in the markets such as lookback, ladder and shout options.
Cliquet options are essentially a form of discretely monitored lookback options, albeit with three differences in practice:
< [t.sub.n] = T, one can write the payoff of a cliquet call as follows :
It must be pointed out that, in the markets, the term "cliquet", when applied to a call option, is sometimes used interchangeably to refer to a ratchet option, whereby the strike price resets at each fixing date to the prevailing stock price while at the same time locking in the performance of the previous period, thus yielding at expiry the following payoff:
Ratchet options are simply a portfolio of forward starting options, hence they admit perfect static replication, unlike cliquet options (Buetow, 1999; Matosek, 2008).
There are no restrictions on the location of the fixing dates over [0,T] in a cliquet option contract.
The specificity of cliquet options is better grasped through a short analysis of their differences with alternative contracts that also embed a lock-in mechanism.
In other words, the difference with a cliquet option is two-fold: there are no fixing dates and the maximum level that can be locked in is bounded.
In contrast to a ladder option, a cliquet option does not require its holder to have precise anticipations on a set of target price increases in the underlying asset, which is attractive in uncertain markets or when you do not have enough expertise.