Was reading a blog post on using a dupire local vol model to price TARFs. It's not a product i'm familar with, so i've been trying to work some examples for fun to understand how they work.

They key feature, as I understand it, is that the TARF comes with an "off-market" strike, but is subject to a "profit cap", and knocks out when reached.

It all seems fairly straightforward at first glance but there is one basic question which I'm genuinely not sure i've understood correctly.

When the cash flows are determined on the various settlement days, is it only the sum of positive pay-offs that are compared to the knock out cap? or is it the sum of all payments? Put differently, if the TARF is close to knocking out, but then on the next settlement a large loss is registered, is the TARF now less likely to knock out on the next settlement, or is it stuck at it's previous "high watermark"?

Many Thanks