An Introduction to Exotic Option Pricing

Chapter 8

Lookback Options

8.1 Introduction

In general terms, lookback options are path-dependent exotic options whose payoffs depend not only on the underlying asset price at expiry, but also on the maximum or minimum asset price over some pre-defined monitoring window. Lookback options are sometimes called hindsight options or options of least regret. The latter name comes from the observation that the payoffs of these options can be tailored to minimize the chance that they finish out-of-the money. Lookback options may also be used to hedge against large fluctuations in the underlying, or to optimize timing into or out of the market. For example, a floating strike lookback call option (which we shall define presently) effectively allows the ...