In this paper we will discuss about the lookback option. It is basically a derivative instrument. Lookback options are traded on the basis of the underlier value, which is achieved throughout the life of the options. Lookback options are of two types, floating strike and fixed strike lookback option.
A lookback option is settled on the basis of either minimum or maximum underlier value achieved till the option expires. At the time of expiration, the option holder will be able to “Look Back” over the entire option period and plan for the next option on the basis of the previous experience, that is which this option is named as lookback option.
Lookback options are of two types: fixed strike lookback option and floating strike lookback option. The former is a cash settled option whose strike is set in advance. Fixed strike lookback options are traded on the basis of optimal value achieved by the underlier over the entire option period.
On the other hand, a floating strike lookback option is traded on the basis of a strike, which is equal to the optimal underlier value throughout the entire option life.
Moreover, lookback options are structured as Calls or Puts. In case of a call fixed strike lookback option, the trading is done on the basis of highest value achieved by the underlier. So the payoff of the Call will be greater than zero while, for a Put fixed strike lookback, the lowest underlier value is taken. Therefore, the payoff of a Put will be greater than that lowest value and so are the cases for the Call floating strike lookback option and Put floating strike lookback option.
Although lookback options are very popular, they are very expensive. It is basically a speculative device, that is, it does not imitate the business liabilities.