Business, Legal & Accounting Glossary
A path-dependent option whose payout depends upon the maximum or minimum underlier value achieved during the entire life of the option. Call or put option whose strike price is not determined until the option is exercised. At the time of exercise, the holder can exercise the option at any underlying price that has occurred during the option’s life. In the case of a call, the buyer will choose the lowest price, and in the case of a put, the buyer will choose the highest price. The premium on such options tends to be high since it gives the buyer great flexibility, and the writer has to take on a lot of risk.
A lookback option is a type of exotic option that allows an investor to look back over the period to maturity and determine the ideal execution strategy for the lookback option. There are two primary types of lookback options: fixed and floating. In the case of a fixed lookback option, the investor is allowed to choose the optimal execution point over the entire life of the lookback option, with the strike price being predefined. Whereas with a floating lookback option, the strike price of the option is automatically set at the highest or lowest price of the underlying over the lookback option’s life. The flexibility offered by the lookback option significantly decreases the chance that the lookback option will expire worthlessly. However, at the same time, this flexibility also makes lookback options one of the most expensive types of exotic options. Despite the high cost of lookback options, they are valuable in that their flexibility removes the problem of market timing to a certain extent.
A lookback option is a path-dependent option settled 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:
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).
path-dependent option
Russian option
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This glossary post was last updated: 6th November, 2021 | 0 Views.