What Is a Shout Option?
A shout option is a type of investment that provides a certain level of guarantee to an investor. The investor can shout out at different points before the investment matures, locking in any current profit to guard against possible losses. Because of this option, shout options are generally used for investment opportunities that are considered high-risk.
The investor can also exercise a shout option to make other adjustments to the investment before it reaches maturity. For example, the option can reset the investment’s strike price or exercise price, changing the amount of money the investor can charge to sell the financial instrument once the investment reaches maturity. A shout can even allow an investor to alter the amount of time before the investment reaches maturity.
Both parties, the investor and the party seeking investment funds, agree to the terms of a shout option at the inception of the investment opportunity. All of the terms of the shout, including what an investor can choose to exercise his shout option on and at what times, are detailed in the investment contract. The rules governing the use of shouts before the investment reaches maturity can either be few and simple, or many and very complex.
In many cases, a shout option protects investors while increasing the risks taken by an investee. In the event that the underlying asset, or the financial instrument backing the investment, experiences a decrease in value from the beginning of the investment to the investment’s maturity, the investor using a shout can stand to benefit. The investee, or the party that originally offered the investment opportunity, however, stands to lose money in such a transaction.
The cost for a shout option is more than for a traditional option. The price increase is higher if the investment is perceived as more volatile, since such an investment is more likely to provoke investors to exercise their shout option. This, of course, means the investors are more likely to make a profit from the investment, than if they did not have a shout. Additional shouts for the same investment further increase the cost of the investment.
By definition, a shout option is classified as an exotic option. Unlike American or European options, which have straightforward investment contracts, exotic options can have complex contract terms that change based on multiple variables. Because of their complex contracts, shout options and other exotic options are not traded on an exchange, such as the New York Stock Exchange, but instead are traded over-the-counter in a marketplace such as NASDAQ.
Discuss this Article
Post your comments