The reverse cliquet and Napoleon option are structured products that are short the variance of periodic returns — they pay well when every period is calm (all returns moderate) and suffer when one period is extreme. This is the opposite model sensitivity from the LCGF: while the LCGF is long the forward smile (benefits from positive vol in each period), the reverse cliquet is short the worst period — it loses if any single period is extreme. Understanding the pricing discrepancy between local vol and stochastic vol for these products reveals the full model-risk spectrum of the structured product desk.
Learning objectives. By the end of this note you should be able to:
- state the reverse cliquet and Napoleon option payoffs;
- explain why these products are short the forward vol;
- compute the model sensitivity (local vol vs Heston) for a Napoleon option;
- describe the hedging challenges created by the "worst period" structure.
In this lesson
- 3.1 The reverse cliquet
- 3.2 Napoleon options
Before you start
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