Options contracts that vary from the traditional ones in terms of strike prices, payment structures or expiration dates are termed exotic options. Exotic options, an advanced type of options contract, offer more features than traditional ones. They can be tweaked to suffice the desired profit outcome of the investor. Shout options are a type of options contract that falls under the purview of exotic options.
A shout option allows a trader to lock in profits at specified times before the expiration of the contract. Buyers can lock in profits at the intrinsic value of the underlying assets. The intrinsic value of an option is the actual worth of the concerned underlying asset.
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Intrinsic values, in cases of shout options, depend on a number of factors, such as volatility and the number of shout opportunities. However, the intrinsic value is usually different from the current market price. A shout option allows the buyer to declare a certain intrinsic price. Since it is an exotic option, that part too is negotiable. This allows the buyer to lock in profits at the intrinsic value without risk of loss. At the same time, the buyer can continue to participate in future gains.
A shout option, as explained, is a type of advanced options contract. Within this, the buyer has the choice of making profits on an asset before the expiration date of a contract. In doing so, they are guaranteed profits obtained from a rise in the price of the underlying asset. Bearish traders may also go for put calls in shout options. In this case, the buyer can benefit from price drops in the concerned asset.
Thus, shout options allow for minimizing any risks related to price changes before the actual contract expires. Buyers, depending on how many shout rights they get to exercise, also have the luxury to participate in future gains in the lifetime of the contract.
The shout option buyer can “shout” out the intrinsic value they wish to place to the writer. A writer is another term for the seller of an options contract. The writer is the one who charges a premium against the right to buy or sell an option. Even if the buyer locks in profits early, the contract continues to be an open one.
This promises a minimal amount of profit, even in the event that the intrinsic value of the asset decreases after the shout. On the other hand, if the intrinsic value increases, the buyer of the option can still participate in those gains.
To explain shout options with an example, let us consider an asset to have a strike price of ₹60. Before the option expires, the underlying asset price rises to ₹70. Shout options allow for option buyers at certain intervals to 'shout' or lock in the profits. In this case, the shout will bring a guaranteed profit of ₹10. After this point, the trader still retains the call option. This means that they can make additional gains if the underlying rises even higher than ₹70 before it expires.
On the other hand, in the event that the underlying dips below ₹70, the trader still has the right to profit as if the price was still ₹70. This is how a shout option can be extremely useful. It can be used by the buyer to cement the current gains. Especially, in case they feel that the intrinsic value of the asset might dip in the future before the expiration of the contract. Nevertheless, they can also use a shout as a way to guarantee the current profits, thus minimizing risks.
A shout option is an exclusive type of option. As it provides an added layer of security, the prices are often higher than that of a traditional options contract. That is why shout options are usually reserved for assets that are volatile in nature, i.e., assets whose prices are subject to constant ups and downs.
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