The Lookback Option

Paper Summary:

This paper explains that a lookback option is path dependent, based on the maximum or minimum underlying value reached during the entire life of the option. The author points out that, at the expiration date of these options, the holder may "look back" over the life of the option and exercise it, based on the optimal underlying value achieved during that period thus giving the holder the ability to buy an asset at its lowest price or sell it at its highest price achieved over the life of the option. The paper relates that, through the lookback option, the investor can achieve economic intelligence and value through the benefit of hindsight; however, lookback options carry risk and are more expensive than standard options. The paper includes several formulas.

Table of Contents
Definition of Options
Call and Put Options
Introduction to Lookback Options
Lookback Options in Greater Depth
The Model
Option Pricing
Discrete Lookback Options
Case Study of Lookback Options

From the Paper:

"Put options conversely involve the investor aiming for a stock price decrease. The put option, as mentioned in the introduction, allows the holder to sell an asset by a particular date for a certain price. An example demonstrated by Hull (2006) involves a European option involving an investor who buys the option to sell 100 shares with IBM for a strike price of $70. If the current stock price is $65 and the expiration date is in three months, Hull supposes for example that the option to sell one IBM share is $7. The initial investment, therefore, will be $700."

Sample of Sources Used:

• "About Lookback Options." Montgomery Investment Technology/Financial Tools. Date accessed: 29 July, 2006. Available: <http://www.fintools.com/doc/exotics/exoticsAbout_Lookback_Options.html>
• Copeland, Tom, Koller, Tim and Murrin, Jack. Valuation: Measuring and Managing the Value of Companies. Third Ed. Canada: John Wiley & Sons, 2000.
• "Global Derivatives - Lookback Options." Global Derivates online. Date accessed: 29 July, 2006. Available: <http://www.global-derivatives.com/options/lookback-options.php>
• Hooke, Jeffrey. Security Analysis on Wall Street: A Comprehensive Guide to Today's Valuation Methods. Canada: John Wiley & Sons, 1998.
• Hull, John C. Options, Futures and Other Derivatives. Six Ed. New Jersey: Pearson Prentice Hall, 2006.

More papers on The Lookback Option:

• Term Paper # 129249 : "Economics: Lookback Options"
• Research Paper # 59875 : "The Black-Scholes Formula"
• Analytical Essay # 3935 : "James Baldwin's "The Fire Next Time."

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