Equity cliquet options volumes are swelling because insurers have started deploying the once exotic instruments to back annuities. The insurers, including American Equity, Aviva and Lincoln Financial Group, are offering annuities based around cliquets because they can be structured to provide guaranteed payouts.
In a cliquet, or rachet, option gains are periodically locked in for the buyer and the strike reset. The current trades are typically linked to U.S. equity indices and reset each month at-the-money with maturities around one to two years. Although the annuities tend to be out to 10 years or more, the insurers go to the Street to hedge the options to get better pricing. In turn derivative firms are hedging in the interdealer market.
Officials at the insurers did not return calls, so why the options have taken off now is unclear. One equity sales head suggested it may be because insurance companies are a little slow and move in packs. He noted that dealers began shopping the structures to insurance companies when other investors lost interest two or three years ago but without success. "It's taken a long time for them to get comfortable with [cliquets]," he noted.
Interdealer brokers said they have seen as much as three times typical volumes of cliquet options trade over the last few months. All of the big firms are reportedly involved.
Because of the way they are structured, cliquets offer investors better payouts when the underlying is volatile. As implied volatility has declined, cliquets lost their appeal for retail and high-net-worth investors who have spurned low income-paying equity structures for the chance for high upside participation. Insurers have now started taking up that slack.
