LOOKBACK OPTION
Lookback options give the holder the right at expiry to exercise the option at the most favourable rate or price reached by the underlying over the life of the option. As with average options, the strike may be either fixed or floating. With an optimal rate (or price) lookback option, the strike is fixed at the outset and the option will pay out against the highest (for a call) or lowest spot (for a put) reached over the life of the option, irrespective of the spot at expiry. The option will usually be settled in cash. Since the option is likely to have a larger payout than the corresponding plain vanilla option, it commands a larger premium. The strike for an optimal strike lookback option, on the other hand, is not fixed until expiry, when it is set to be the highest (for a put) or lowest spot (for a call) over the option’s life and exercised for cash or physical against the spot prevailing at expiry.