Daly made 21 competitive appearances for the club after joining from Droylsden in January 2019.
South Shields manager Graham Fenton said: “We’ve been closely monitoring Luke and have ultimately come to the conclusion that we’re not able to offer him a deal to stay with us next season.
“It was a very difficult decision to make but we felt it was the correct call based on a lot of factors.
“At the moment, we wouldn’t foresee Luke impacting the first-team for quite a significant period of time yet.
“We realise that he has been through an extremely difficult period with his injury and his recovery has been hampered by the Covid situation, which has meant it has taken him a lot longer than would otherwise be expected to get up to speed.
“Because of that, Luke’s journey at the club has sadly come to an end, for the moment at least.
“You never know what is around the corner in football though and we know Luke is a very good player who has the potential to go somewhere and perform exceptionally well over the next 12 to 24 months.
“If that happens we could be picking up the phone to him again in the future but this is a club which demands success immediately and we just feel Luke isn’t quite ready to perform at the level required yet.
“We’d like to thank him for all of his efforts here. He has been a fantastic young person and player to work with and we wish him all the best for the future, wherever that may be.”