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A
lookback option
is a path dependent option settles based upon the maximum or minimum
underlier
value achieved during the entire life of the option. Essentially, at
expiration,
the holder can "look back" over the life of the option and exercise based upon
the optimal underlier value achieved during that period. Lookbacks can be structured as
puts
or calls and come in two basic forms:
 A
fixed strike lookback option
is cash settled and has a strike set in advance. It is exercised based upon the
optimal underlier value achieved during the life of the option. In the
case of a call, this is the highest underlier value achieved, so the call has a
payoff equal to the greater of: zero or the difference between that highest
value and the fixed strike. In the case of a put, the optimal value is the
lowest underlier value achieved, and the payoff is the greater of: zero or the
difference between the strike and that lowest value.
A floating strike
lookback option can have cash or
physical settled. It settles based upon a
strike that is set equal to the optimal value achieved by the underlier over the
life of the option. In the case of a call, that optimal value is the lowest
value achieved by the underlier, so the call has a payoff equal to the
difference between the value of the underlier at expiration and the lowest value
achieved by the underlier over the life of the option. In the case of a put, the
payoff is the difference between the highest value achieved by the underlier and
the value of the underlier at expiration.
Lookback options have obvious appeal, but they are expensive.
Their structure doesn't mimic typical business liabilities, so they are largely
a speculative device.
Classic papers on pricing lookbacks are: Goldman, Sosin and Gatto
(1979), Garman (1989) and Conze and Viswanathan (1991).
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 Asian option An option whose
expiration value depends on
the average value of an underlier over a specified period.
barrier option A path-dependent option
that terminates or is activated by the underlier reaching some
"barrier" level.
binary
option A type of option which features a
discontinuous expiration value.
derivative
instrument An instrument
which derives its value from the value of other financial
instruments. Article includes a list of vanilla and exotic derivatives.
option pricing theory The
body of financial theory used by financial engineers to value options and other
derivative instruments.
path
dependence A property of certain exotic options whose terminal
value depends upon the path taken by the underlier during the life
of the option. |
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 Conze, A. and R.
Viswanathan (1991). Path dependent options: the case of lookback
options, Journal of Finance, 46, 1893-1907.
Garman, Mark (1989).
Recollection in tranquility, Risk, 2 (3) 16-19.
Goldman, M. Barry, Howard B. Sosin and Mary
Ann Gatto (1979). Path-dependent options: buy at the low, sell at
the high, Journal of Finance, 34, 1111-1127
Kat, H. M. (1995). Pricing lookback options
using binomial trees: An evaluation, Journal of Financial
Engineering, 4, 375-397. |
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