In calculating payoff for Lookback Options, is it necessary to know whether it's fixed/floating?

[Steve Jobs]

I have a practice question about a lookback call in which it's asking to calculate the difference in payoff between fixed and float; in another practice question, it's asking to calculate the payoff for a lookback put without specifying whether it's a fixed or float.

In the put question, how can I calculate payoff if I don't know whether it's fixed or float? is it necessary to know?

 

[David Harper CFA FRM]

A floating and fixed lookback put could have the same payoff (actually, that's such a good question itself I am going to save it for my own practice question!) but typically they would not. I think several texts (e.g., McDonald, Kolb) will refer only (or primarily) to a "lookback put" such that lookback put implies max(0, S[max] - S[t]); i.e., the "default" lookback is what Hull calls the floating lookback put. This more common convention ("selling the asset at the highest price during the life") does not require a strike price, is how I remember it (floating --> no strike needed). The fixed lookback is max(0, K - S[min]) does require an exercise price.

So, unless the path meets a unique condition, I think you'd need to know the difference; it's possible the question is smart that way.

But the FRM employs Hull so does distinguish between fixed and floating lookbacks (unlike some authors). Thanks,

 

[Steve Jobs]

Hi David, thanks and sorry for the late reply.

So I have to practice old FRM sample questions to get used to Hull understanding and not to search on the net because other authors might have different opinion.

It's an issue of having standard terminology in finance.

Thanks again David,

 

[Steve Jobs]

Hi David,

I found 2 practice questions related to lookback options in which only in one of them, it's not mentioned whether it's floating or fixed.

However, the answer provided to the 2 practice questions is consistent with the logic you mentioned in your post. Hence I'll be following the same logic in the exam.

Thanks and regards,