What Is a Shout Option?

A shout option is an exotic options contract that allows the holder to lock in intrinsic value at defined intervals while maintaining the right to continue participating in gains without a loss of locked-in monies.

Key Takeaways

  • A shout option allows the buyer to lock in the intrinsic value of an option by "shouting" at the writer to do so.
  • Shout options are exotic options, and therefore their terms can be negotiated.
  • Shout options are more expensive than standard options because of their flexibility to lock in profit while still participating in future profit.

Understanding Shout Options

The shout option buyer "shouts" at the option writer to lock in the gain, yet the contract still remains open. The shout guarantees a minimum of profit, even if the intrinsic value decreases after the shout. If the option increases in value after the shout, the option buyer can still participate in that.

Shout options allow one, or multiple points, where the holder can lock in gains. As an example, if a call shout option has a strike price is $50 and the underlying asset trades to $60 before expiration, the holder may "shout," or lock in the $10 the option is trading in the money (ITM). The holder still keeps the call option and can make an additional profit if the underlying moves even higher before expiration.

However, if the underlying asset drops below $60 before expiration, the holder still gets to exercise at $60. The shout is useful for locking in gains if the buyer thinks the option may lose its intrinsic value, or simply to lock in profit as the option is increasing in value.

Basically, after each shout, the profit floor moves higher for calls options. Only paper profits made after a shout are subject to reversal should the underlying asset decline in price.

A shout put option works the same way. As the price of the underlying drops, the option buyer can shout to lock in the intrinsic value of the option. If the price of the underlying rises after that, the buyer is still guaranteed the intrinsic value they locked in.

As exotic options that trade OTC, these contracts can have flexible terms, including multiple shout thresholds.

Pricing 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 sensitive to 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.

The writer of the option will demand the premium, or cost of the option, be large enough to cover reasonable movements in the underlying. In pricing the option they may use a similar standard option as a reference point, and then add additional premium to account for the shout feature.

Example of a Shout Option

Shout options are not actively traded, but consider the following hypothetical scenario to understand how this option works.

A trader buys a shout call option on Apple Inc. (AAPL). The option expires in three months, has a strike price of $185, and the buyer is allowed to shout once during the term of the option.

The stock is currently trading at $180. The option premium is $11, or $1,100 for one contract ($11 x 100 shares).

The buyer's breakeven point for the trade is $196 ($185 strike + $11 premium), although they can shout to lock in intrinsic value at any point when the price of Apple rises above $185.

Assume the buyer is expecting a positive earnings release which will push the price over $200 in the coming months.

One month after purchase the stock is trading $193. While this is still less than the buyer's breakeven point, they decide to shout. This locks in the intrinsic value of $8 ($193 - $185 strike). This guarantees that they won't lose their whole premium ($11), and will get at least $8 worth of it back.

Now consider two different scenarios after the shout:

  1. If the price drops back below $193 and stays there until expiry, the trader still gets the $8 in intrinsic value they locked in. In this case, they still lose $3 ($11 - $8) or $300 per contract but at least they didn't lose the whole premium which could happen if Apple stock is below $185 when the option expires.
  2. Now assume the price of Apple continues to rise and is trading at $205 when the option expires. The option has $20 in intrinsic value ($205 - $185 strike). The buyer is still able to collect the $20 (or $2,000 per contract) even though they shouted to lock in $8 in intrinsic value. They still get the higher value since the option expired with greater value than the shout. In this case, the buyer makes $9 or $900 per contract ($2,000 - $1,100).