A lookback option is different from most other options in that the holder is able to 'lookback' at the end of the option's life and excercise the option at a more favourable strike price.. Lookbacks can be either call (buy) or put (sell) and have two principal forms:
- Floating Strike Lookback allows the holder to exercise the option to give the highest payoff based on the price of the underlying asset on the expiry date versus the maximum or minimum of the asset price during the option's life. For example, a call lookback on a stock would give a payoff of the price of the stock on the expiry date less the minimum price of the stock during the option's life.
- Fixed Strike Lookback allows the holder to exercise the option to give the highest payoff based on the underlying asset price over the option's life versus a fixed strike. For example, a call lookback on a stock would give a payoff of the maximum price of the stock during the option life less the fixed strike.
In addition to the black scholes inputs the lookback pricing models also require the input of the prevailing Maximum (for a put option) or Minimum (for a call option) price to date. If the option is being valued at its inception then the Max or Min is set equal to the spot price.
DerivativeOne features a free Lookback Option pricing tool