Cliquet Options

Cliquet options consist of a group of individual options that become active at certain points in the future. These exotic options are ideal for traders navigating high volatility markets. Read on for a review of how cliquet options work, as well as a list of benefits, drawbacks and key strategies that can be used.

Below we list the top-rated brokers that offer retail options trading in 2022.

What Are Cliquet Options?

Cliquet options consist of multiple at-the-money (ATM) forward start options. This means that the individual contracts within a cliquet option do not become active until the previous one has expired. The strike price of each individual option is determined by the market price at which the previous contract expires.

With cliquet options, traders are aware of the total premium before they purchase the contract, as well as the number of “reset dates” which will change the strike price. However, all the strike prices apart from the first one will be unknown when the position is opened. They are path-dependent options, meaning that the prices during the life of the contract matter, rather than merely the underlying price once the contract reaches final maturity.

A cliquet option could be three years in length, spanning across 2020, 2021 and 2022 for example, but the time frame depends on the terms of the contract. Generally, options contracts for stocks have a volume of 100 shares of the underlying asset. Cliquet options are also known as “ratchet options.”

Trading cliquet options guide explained

How Cliquet Options Work

The underlying asset of a cliquet option is usually an index, a stock (for example, Amazon or Roblox), or a basket of indices and/or stocks. However, contracts may also be available for a cryptocurrency like Bitcoin too.

Trading cliquet options incurs a premium. The premium is the value of each individual option combined. This means that trading a cliquet option is more expensive than buying one individual option with the same final maturity.

However, the justification for purchasing a cliquet option is that it helps manage risk in a volatile market. This is because with a single option, it is often the case that the underlying market price does not meet the strike price and therefore, the premium is lost. Although this may happen with one individual option within a cliquet, the probability of it happening with all the options within it (particularly where the cliquet is made up of three or more forward start options) is lower. Paul Wilmott published a paper titled “Cliquet Options and Volatility Models,” which illustrates how the contract price will vary depending on skew volatility.

As the entire premium amount is known before the contract is purchased, buyers will always know the total amount that they could lose. Traders could alternatively purchase each individual option in turn, however the price of these options in the future would be unknown.

Example

Let’s examine a cliquet option trading scenario…

An investor purchases a three-hour cliquet option, with each option within it lasting one hour. The premium for each option is $50, therefore in total the trader pays a $150 aggregate premium. This is the total amount that they can lose. The strike price after one hour is set at $1,000. Unfortunately, after one hour the underlying stock price only reaches $900. This means that they lose the premium for that particular period ($50).

The $900 market price becomes the strike price for the end of the second hour. Fortunately for the trader, the stock price ends the second hour at $1,200. The profit is the difference between the underlying stock price and the strike price, minus the premium. This amount is then multiplied by the contract volume, and finally any fees or commissions charged by the broker are subtracted.

$1200 becomes the strike price for the last hour but unfortunately, the stock finishes below this level at $1,100 and the trader loses their premium for that period ($50).

As can be seen from this activity, traders can lose in certain periods of the cliquet option but win in others. Just because you lose the premium for one trading period does not mean you cannot still make a profit overall.

Key Characteristics

The key characteristics of trading cliquet options are:

  • Aggregate premium and number of reset dates are known in advance
  • Cliquet premium is the present value of the options within it combined
  • The underlying market price at each reset date becomes the strike price for the next period
  • Profit can be paid out after each reset date or the accumulated profit can be paid out upon final maturity
  • Commonly used by traders in volatile markets

History

The history of options, in general, can be traced back hundreds of years. However, options only began officially trading in a standardized format in 1973 when the Chicago Board of Options Exchange in the US was formed. This was accompanied in the same year by Fisher Black and Myron Scholes creating a formula that could calculate a valuation for options, enabling traders to make more informed decisions as to whether options represented value for money.

Trading cliquet options terms and definitions

The introduction of online trading towards the end of the 20th century made options trading more accessible to retail investors wanting to trade from the comfort of their own homes. These changes have opened up the trading of exotic options like cliquets to many amateur investors, as well as traditional institutional investors like hedge funds.

Benefits Of Trading Cliquet Options

  • Safer and more risk-averse than vanilla options in volatile markets
  • Often cheaper in volatile markets than buying multiple options one at a time
  • Suitable for traders who are confident of overall market direction but believe there is a possibility of minor reversals along the way

Drawbacks Of Trading Cliquet Options

  • A coupe option is similar and often cheaper
  • More complex than vanilla options so can be difficult for novice traders to initially get to grips with
  • Often more expensive than buying the options individually in less volatile markets

Strategies

The strategies detailed below are based on the trader having a good understanding of the underlying market…

Breakout Strategy

Traders will often find that the price of the underlying market fluctuates between two bands on a chart: the support and resistance levels. The support band is situated at the bottom of the range and the resistance band at the top.

The existence of this range makes sense: as the price of the asset moves towards the resistance level, the asset is in overbought territory where the number of sellers starts to outweigh the number of buyers (further insight into this can be sought through an indicator such as the Money Flow Index (MFI)).

When the price breaks out of this range, this may indicate the beginning of a bullish run (if above the resistance level) or a bearish run (if below the support level). The trader would open the cliquet option position once the breakout has occurred. Trading cliquet options in this scenario can help protect against any temporary reversal in the trend.

Delta and gamma can be used to understand how the price of the underlying asset impacts the price of the option.

Moving Average Crossover

The moving average crossover strategy is useful for those trading cliquet options because it can help identify the beginning or strengthening of a trend. It involves using a fast-moving average (20 periods) and a slow-moving average (60 periods) on your chart.

When the fast-moving average crosses above the slow-moving average, this indicates that a positive trend may be forming, as the fast-moving average is more susceptible to recent price movement. The crossover is the point when the trader would purchase a call cliquet option. If it’s predicted that the trend will be turbulent, the trader may wish to purchase a cliquet option with a greater number of reset points (perhaps 3 or more) to limit potential losses.

Comparison With Other Options

Traditional options are usually referred to as “vanilla options”. Although vanilla options are more appropriate in stable markets, they are typically riskier in more volatile ones. This is because with a vanilla option, the trader is essentially putting “all their eggs in one basket.” If the underlying market price does not reach the strike price, they lose the entire premium with no hope of recovering the losses. However, trading cliquet options provide some protection against that risk as they are made up of multiple options with different expiry times.

Coupe options are similar to cliquet options in that they typically have multiple reset periods and expiry points. Although they are generally cheaper, they are also more similar to vanilla options and therefore may not be as appropriate in the most volatile markets. Unlike with a cliquet option where the strike resets to the current market spot price, a coupe option resets to the worst of (this means higher of) either the current market spot price or the strike price for the previous period.

In a similar fashion, Asian options take the average of the underlying asset’s price over a certain period rather than simply comparing the strike price to the spot price at the point of expiry. As an average is used, this makes Asian options popular with investors looking to hold their positions over the long-term. However, as is the case with vanilla options, there is no “second-chance” as there is with trading cliquet options. If the strike price is not met, the trader will incur a loss.

How To Get Started

1. Find A Suitable Broker

Traders should first seek a broker that offers cliquet options. Research the commissions that the brokerage charges, as well as other fees such as deposit and withdrawal costs. Remember that some brokers will try to entice traders with a low headline fee or zero commission, but will have expensive charges elsewhere, for example, currency conversion or withdrawal fees. It is also worth checking whether the broker provides a demo account so you can get used to trading cliquet options and test your chosen strategy.

Other aspects to research include whether the broker is a market maker or an ECN broker, whether they give requotes, the minimum margin (for those wanting to use leverage), and their level of customer support. For example, you should check whether the broker has a phone number, email or live chat system in the case that a platform crash occurs or you need to make a specific request.

Other useful features include a mobile app available for download so you can trade cliquet options on the go. The quality of your experience will vary depending on what trading platform the broker uses. Does it have a range of indicators as well as different graph formats such as candlesticks and barcharts? Is it supported by Windows 7, Windows 10 and macOS? Is there a web-based version available?

Once you have registered with your chosen broker, log in and spend time familiarizing yourself with all the features before you begin trading cliquet options.

2. Monitor The Market

The success of any cliquet options trading strategy depends on a strong understanding of the underlying market. It is regularly quoted that 80-90% of all traders lose money and it has also been stated that more than 75% of day traders end up quitting within two years. These failures are often the result of a lack of market research and preparation before opening positions.

Identify any trends, patterns, ranges or reverse in a trend to build up a comprehensive dataset, and then buy or sell a put or call option based on this. Trading platforms such as MetaTrader and TradingView can help with building your understanding of the market, as well as news websites such as Yahoo Finance.

Fundamental analysis is not as important for those day trading cliquet options, but you still need to be aware of market events happening that day. Keep an eye on Twitter and make use of economic calendars, which are provided by most brokers. Beginners may also want to learn basic trading analysis skills either by reading a relevant book, exploring an online course, watching a video on a YouTube channel, or navigating a website such as Quizlet or even Wikipedia.

Some brokers such as Webull, NinjaTrader and Robinhood, have comprehensive education sections. Social media platforms such as Twitter and Facebook can be a good place to engage in discussion and ask questions, as is the case with forums like Reddit and Discord.

3. Open Your Position

Once you are satisfied with the initial strike price, number of resets and overall length of the cliquet option, you should open your trading position. Remember to ensure that your portfolio is diversified: ideally, you want to open cliquet options in different underlying markets.

For example, a trader buys a cliquet option on the Nasdaq 100 that falls 5%, so they lose capital. However, they have already diversified their total capital between the Nasdaq 100 and the FTSE 100 (which gained 3%). This has helped them to reduce exposure and limit losses.

Indices naturally give more diversification vs individual stocks. The unit “R” can help those trading options to analyse the reward and risk of a particular strategy or algorithm, as can a profit calculator.

Final Word On Trading Cliquet Options

Cliquet options are designed to reduce risk and help traders to navigate markets with high volatility. Whether you are based in the USA, UK or Australia, trading cliquet options can look like a successful and cost-effective option type for many different kinds of investor. Make sure that you research your chosen broker and stick to a definitive trading strategy. Also use our overview above to get started today.

FAQ

How Does Trading Cliquet Options Work?

Similar to regular options, with cliquet options traders buy a call option if they think the market is bullish or buy a put option if they think that it’s bearish. The key difference is that cliquet options are made up of several forward start options with multiple strike prices.

Do I Need To Research The Market To Trade Cliquet Options?

Yes, understanding and spotting trends in the underlying market is essential for becoming a successful options trader. Without completing research and analysis, cliquet options trading becomes little more than gambling.

Do I Have Alternatives To Trading Cliquet Options?

Yes, there are some alternatives to trading cliquet options. Coupe options are most similar to a cliquet option and are generally cheaper. Those trading in more stable markets may want to stick with regular or “vanilla” options.

Can You Automate A Cliquet Options Trading Strategy?

Yes, there are automated cliquet options trading bots available. Code written in programming languages such as JavaScript (JS) and Python, and perhaps shared on an open-source platform such as GitHub or RStudio, can be used to create trading bots that implement options strategies.

Will I Know How Much I Could Lose Before I Purchase The Cliquet Option?

Yes, traders will know the full aggregate premium before purchasing any cliquet option. However, the potential loss for those selling a cliquet option is unknown as it depends on the movement of the underlying market.