Lookback Option

Everyone hates regrets. "I should've studied medicine instead of Eastern Ukrainian Interpretive Dance." Or, "I shouldn't have eaten those three-day-old oysters I found under the passenger seat of my car." Or, "I should have sold that stock a week ago, before it suffered that sudden drop."

The lookback option can help with that last one. It's basically a short-term option-market time machine.

Most options have a specific expiration date. Depending on the type of option, you can only exercise the option on the expiration date, or you can exercise it any time before the expiration date...but you have to pick the single moment at which you exercise it.

The lookback option is an exotic option that pays off at the underlying asset's highest or lowest price during the period (depending on the type of option). In effect, it's as if you could "look back" and pick the best time to exercise it.

You hold a lookback option to buy 200 shares of High Flyer Inc. with a strike price of $25. The option expires in June. During May, the stock reaches $35, well into the money. However, it falls from there. By the June expiration, it's trading at $20...a typical option would be out of the money and worthless. But a lookback option lets you cash in at that $35 price. You can essentially cherry-pick the most favorable price the asset reached during the option time period.