A knock-out CMS floor is similar to a Knock-out Floor . The only difference is that instead of the floating rate being based on a reference rate (such as LIBOR), it is based on a long-term swap rate, i.e., the CMS index.
As in a knock-out floor, the knock-out barrier must be set lower than the strike. This means that each underlying floorlet is deactivated (or knocked-out) for a payment period if the swap rate is below the specified barrier.
This option provides the buyer with protection for each payment period, as long as on its fixing date the swap rate is lower than the strike and higher than the barrier. If the barrier is hit in a payment period the underlying caplet is immediately knocked-out (or terminated) for that period only.
A knock-out CMS floor is useful when you need limited protection against a drop in the swap rate because you think rates will only drop to a certain level. Because you have no protection under a certain level, the premium is less than that of the equivalent CMS floor with the same strike.