What is a Shout Option
A shout option is an exotic option contract that allows the holder to lock profits at defined intervals while maintaining the right to continue participating in gains without a loss of locked-in monies.
BREAKING DOWN Shout Option
Shout options allow multiple points where the holder can lock in gains. For a call shout option, if the strike price is $50 and the underlying asset trades to $60 before expiration, the holder may "shout," or lock in the $10 profit. The holder still keeps the call option and can make additional profit if the underlying moves even higher before expiration.
However, if the underlying asset drops below $60 before expiration, the holder still keeps the initial $10 profit. Therefore, if the holder believes the underlying asset will move higher, for a call, but is worried about volatility taking back any interim profit, the shout option allows them to profit anyway.
Basically, after each shout, the profit floor moves higher (for calls). Only paper profits made after a shout are subject to reversal should the underlying asset decline in price.
As exotic options, these contracts may have flexible terms, including multiple shout thresholds.
Defining Shout Options
As with all options, the holder has the right, but not the obligation to buy, in the case of calls, or sell, in the case of puts, the underlying asset at a defined price by a certain date. Shout options are among the option types that allow the holder to modify the terms, according to a predefined schedule, during the life of the options contract.
Because of the uncertainty of what the holder will do, the pricing of these options is complicated. However, because the holder has the opportunity to lock in periodic profits, they are more expensive than standard options. Shout Options are path-dependent options and highly dependent on volatility. The more volatile the underlying asset the more likely the option holder will get the opportunity to shout. The more "shout opportunities, the more expensive the option.
Theoretically, the contract terms may allow the holder to shot immediately, creating a no-lose situation where the worst-case scenario is the that the holder breaks even on the options and only loses the premium paid to purchase it.
Therefore, the writer of the option is almost in a no-win situation and will demand the premium be large enough to cover reasonable movements in the underlying.
For a more realistic application, the first shout date may not occur for several months. Therefore, the seller can profit if the underlying rises minimally, stays flat or declines before the shout date and before maturity.