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What is a Lookback Option?

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  • Written By: Mary McMahon
  • Edited By: O. Wallace
  • Last Modified Date: 27 August 2016
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    Conjecture Corporation
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A lookback or hindsight option is an option which allows the buyer or seller to choose the most favorable strike price for the option, rather than being obliged to buy or sell at market price or a fixed price when the option matures. These types of options tend to be expensive, but they do eliminate a great deal of uncertainty, and they can be advantageous for certain types of investors. As with any type of purchase of a financial instrument, it is advisable to talk to a financial adviser before buying a lookback option.

In the case of a put option, someone is buying the right to sell a given number of units when the option matures, although the seller is not obliged. Call options allow people to buy a given number of units at maturity. With a lookback option, when the option matures, the buyer or seller can literally look back over the life of the option contract and select the best price. A buyer would naturally choose the lowest price, while a seller would choose the highest.

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In the case of a lookback option with a floating strike price, the price is not fixed until the option is exercised, at which point the option is bought at the lowest price or sold at the highest. A lookback option with a fixed strike price, on the other hand, has a price which is fixed, but the option is not exercised at this price. Instead, the history of the option's life is reviewed before settling on a final price.

This is a type of exotic option, meaning that it is an option with special features, as opposed to a vanilla option, in which the details of the option are very straightforward. Lookback options, like other exotic options, can be expensive, and there may not always be a distinct advantage to purchasing this type of option. For this reason, it is important to review the situation and to think carefully before making a commitment to purchase a lookback option.

People with experience in the options market can weigh the available information on their own to make a decision about what to do. For people who are just starting to explore options, however, it is wise to get professional advice to avoid making a costly mistake. A trusted financial adviser can help people select the best deals and can provide information on how to use available funds for investment most wisely and efficiently.

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