The former Fulham, Manchester United, Tottenham and Everton striker signed for the Black Cats on a one-year deal last summer but has not started a Premier League match since. He is now free to depart, although the Northern Irishman noted that the forward may remain with the squad as cover until the end of January.
"As of today, we have told Louis he is free to speak to other clubs and to leave if he can fix himself up somewhere,” O'Neill told the Shields Gazette on Wednesday.
"We have come to an agreement whereby we will cancel the remainder of his contract, shake hands and go our separate ways.
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O'Neill also declared that Saha is the subject of interest from an unnamed South African club, while he went on to speak of the Frenchman's disappointment at his failure to make an impact at the Stadium of Light.
"I have heard that there is some interest in South Africa for Louis and it might be of some interest to him," he noted.
"I wasn't expecting him to be starting 20 Premier League games on the trot or anything like that but I think he's been disappointed.
"In fairness, I think he's been disappointed when he's come on to the field. I think he feels he might have been making a bigger impact. He's had a chat to me and I understand that. This man has had a really good career and he didn't want to be a bit-part in things."