Business, Legal & Accounting Glossary
Put/Call Parity is a principle referring to the static price relationship, given a stock’s price, between the prices of European put and call options of the same class (i.e. same underlying, strike price and expiration date).
This relationship is shown from the fact that combinations of options can create positions that are the same as holding the stock itself. These option and stock positions must all have the same return or an arbitrage opportunity would be available to traders.
Any option pricing model that produces put and call prices that don’t satisfy put-call parity should be rejected as unsound because arbitrage opportunities exist.
The relationship between the price of a call and the price of a put for an option with the same characteristics (strike price, expiration date, underlying). It is used in arbitrage theory. If different portfolios comprised of calls and puts have the same value at expiration, it is implied that they will have the same value leading up to the expiration point. Thus, the values of the portfolios move in lockstep. Portfolio price equality is calculated as c + PV(x) = p + s, where c is the market value of the call, PV(x) is the present value of the strike price, p is the market value of the put, and s is the market value of the underlying security. If the two sides of the equation are not equal, arbitrage profit could be gained by investing in the less expensive portfolio. Analysis of the parity relationship assumes that other factors, such as a dividend, are not taken into account.
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This glossary post was last updated: 20th November, 2021 | 0 Views.