Vous êtes sur la page 1sur 37

Put Call Parity

RAVICHANDRAN
Notation
c: European call option C: American call option
price price
p: European put option P: American put option
price price
S0 : Stock price today ST : Stock price at option
maturity
K: Strike price
D: PV of dividends paid
T: Life of option
during life of option
s: Volatility of stock
price r Risk-free rate for
maturity T with cont.
comp.

2
Put-call parity

• Put-call parity is a financial relationship


between the price of a put option and a call
option.
• The put-call parity is a concept related to
European call and put options.
• The put-call parity is an option pricing
concept that requires the values of call and
put options to be in equilibrium to prevent
arbitrage.
How does the put-call parity work?

 Prices of put options, call options, and their


underlying stock are very closely related.
 A change in the price of the underlying
stock affects the price of both call and put
options that are written on the stock.
 The put-call parity defines this relationship.
How does the put-call parity work?

• The put-call parity relationship is specific in


a way that a combination of any 2
components yields the same profit or loss
profile as the third instrument.
• The put-call parity says that if all these
three instruments are in equilibrium, then
there is no opportunity for arbitrage.
• The relationship is derived from the fact
that combinations of options can make
portfolios that are equivalent to holding the
stock through time T,
• and that they must return exactly the
same gain or loss or an arbitrage would be
available to traders.
What is the implication of put-call parity for
synthetic positions?

• The concept of put-call parity is especially


important when trading synthetic positions.
• When there is a mispricing between an
instrument and its synthetic position, the
put-call parity implies that an options
arbitrage opportunity exists.
Put Call Parity Explanation
• The put-call parity is a representation of
two portfolios that yield the same outcome.
• call option + bond = put option + stock
• The left side represents a portfolio
consisting of a call option and a bond.
(zero coupon bond)
• The right side represents a portfolio
consisting of a put option and a stock.
Put Call Parity Explanation
• call option + bond = put option + stock
• If the price of the underlying stock raises, the put
option expires worthless, the stock gains value, the
call option ends in money, and the bond earns risk-
free rate. Both portfolios have equal value at the end.
• Regardless of whether the price of the underlying
stock grows or falls, both sides of the equation
balance each other.
• If a portfolio on one side of the equation was
cheaper, we could purchase it and sell the portfolio
on the other side and profit from a risk-free arbitrage.
What is the put-call parity formula?

• The put-call parity can be expressed as


follows:
• c + Ke -rT = p + S0
• c – European Call option price
• P – European Put option price
• S0 - Stock price at time t0
• K – Strike Price
• Ke –rT - Present Value of Strike Price
Put Call Parity Relationship Derivation

Assumptions :
1. Non dividend paying stocks
2. Option Style : European
3. call and put options - same strike price K
and the same time to maturity T.
Put Call Parity Relationship Derivation

Portfolio A
• Long one call
• Investment of PV(K) for maturity at T
(Ke -rT ) (zero coupon bond equivalent strike
price)
Portfolio C
Long one put
Long one unit of stock
Put Call Parity contd.
• The initial cost of Portfolio A is the cost of
the call plus the amount of the investment,
which is c + Ke -rT
• The initial cost of Portfolio C is the sum of
the prices of the put and the stock, which
is p + S0
At time T
• If ST < K:
• The call (right to buy) in Portfolio A is
worthless, while the investment is worth K.
• Total value of Portfolio A: K
• The put in Portfolio C is worth K − ST and
the stock is worth ST .
• Total value of Portfolio C: K
• (ie. K- ST+ ST)
At time T
• If ST ≥ K:
• The call in Portfolio A is worth ST − K and
the investment is worth K.
• Total value of Portfolio A: ST
• The put in Portfolio C is worthless, while
the stock is worth ST .
• Total value of Portfolio C: ST
• In other words : Both the Portfolios are worth
max(ST,K)
Put- Call Parity Expression
• The portfolios have identical values in all
circumstances at time T .
• Both portfolios have no interim cash flows
since there are no dividends on the stock
and the options cannot be exercised early
as they are European.
• Therefore, the initial cost of the two
portfolios must also be the same.
• We must have c + Ke -rT = p + S0
Summary
Uses of Put-Call Parity
• One of the most well-known results in
option pricing, put-call parity is also one of
the most useful.
• The first and most obvious use of the
result is in the valuation problem.
• Once we can price European calls on non-
dividend-paying assets, we can derive the
prices of the corresponding put options
Uses of Put-Call Parity
• Put-call parity can be used to check for arbitrage
opportunities resulting from relative mispricing of
calls and puts.
• For example, if we find c + Ke -rT > p + S0, then the
call is overvalued relative to the put.
• We can buy Portfolio C, sell Portfolio A, and make
an arbitrage profit.
• Conversely, if we find c + Ke -rT < p + S0, the put is
overvalued relative to the call.
• Arbitrage profits can be made by selling Portfolio C
and buying Portfolio A.
Uses of Put-Call Parity
• Third, rearranging the put-call parity expression
tells us how to create synthetic instruments
from traded ones.
• For example, since put-call parity tells us that p
= c + Ke -rT − S0,
• we can create a synthetic long put by
• buying a call, investing PV(K), and shorting
one unit of the underlying.
• Similarly we can create few other synthetic
instruments.
Uses of Put-Call Parity

• Put-call parity may be used to judge relative


sensitivity to parameter changes, i.e., the
difference in the reactions of calls and puts to
changes in parameter values
• put-call parity, we have c - p = S0 - Ke –rT
• the difference in the changes in call and put
values caused by a parameter change must
be the same as the change in the right-hand
side of the above equation.
• For example, suppose S0 changes by $1.
Denote the change this causes in call and
put values by dc and dp, respectively
• Then we must have dc – dp = 1
• That is, the change in call value is a dollar
more than the change in put value.
Put Call Parity On European Options on
Dividend-Paying Assets
• Modifying the put-call parity arguments to
allow for dividends is easy
• The only difference that dividends create is
that in Portfolio A, there will be an interim
cash flow when the underlying pays a
dividend.
• There is no corresponding interim cash
flow in C.
• Portfolio A
• Long one call
• Investment of PV(K) for maturity at T -Ke –rT
• Investment of PV(D) for maturity on the
dividend date De –rT
• Portfolio C
• Long one put
• Long one unit of stock
• This changes the initial cost of Portfolio A
to
• c + Ke -rT + De –rT the initial cost of Portfolio
C (p + S0 ) remains the same.
• The portfolios have the same value at T
• c + Ke -rT + De –rT = (p + S0 )
Put Call Parity - American Options on
Non-Dividend-Paying Assets
• When the options concerned are American in
style, it does not suffice to compare the
portfolio values at maturity alone since one
or both options may be exercised prior to
maturity.
• It becomes impossible to derive a “parity”
(i.e., exact) relationship between the prices
of calls and puts
• However, an inequality-based relationship
can still be derived
Arbitrage – Put Call Parity - Illustration

• Stock price is $31,


• Exercise price is $30,
• Risk-free interest rate is 10% per annum,
• Price of a three-month European call
option is $3
• Price of a 3-month European put option is
$2.25.
Arbitrage – Put Call Parity - Illustration

• c + Ke -rT = p + S0
• Portfolio A = c + Ke -rT
• Portfolio C = p + S0
• c + Ke-rT = 3 + 30 * e- 0.1* 3/12 = $32.26
• p + S0 = 2.25 + 31= $33.25
• Portfolio C is overpriced relative to portfolio A.
• An arbitrageur can buy the securities in
portfolio A and short the securities in portfolio
C.
Arbitrage – Put Call Parity - Illustration

• An arbitrageur can buy the securities in


portfolio A and short the securities in portfolio
C.
• The strategy involves buying the call and
shorting both the put and the stock, generating
a positive cash flow of
• - 3 + 2.25 + 31 = $30.25 up front.
• When invested at the risk-free interest rate, this
amount grows to (Future value of $30.25)
• 30.25 * e0.10*.25 = $31.02 in three months.
Arbitrage – Put Call Parity - Illustration

• If the stock price at expiration of the option is


greater than $30, the call will be exercised.
• If it is less than $30, the put will be
exercised. In either case, the arbitrageur
ends up buying one share for $30.
• This share can be used to close out the short
position.
• The net profit is therefore
• $31.02 - $30.00 = $1.02
Summary – Arbitrage Example
• Arbitrage opportunities when put–call parity does not
hold. Stock price = $31; interest rate = 10%; call price = $3.
Both put and call have strike price of $30 and three
months to maturity.
Put-Call Parity relationship
• Put-Call parity says that:
• p + S0 = c + Ke-rT + D (in the case of
dividend paying stock)
Put-Call Parity relationship
 This means that one can replicate a put
option through a combination of the
underlying stock, the call option, and a
position in the risk-free asset.
 p = –S0 + c + Ke-rT + De –rT
 Alternatively, one can replicate a call
option through a combination of the
underlying stock, the put option, and a
position in the risk-free asset.
 c = S0 + p – Ke-rT – De –rT
Put-Call Parity relationship
 Alternatively, one can replicate a risk-free
position through a combination of the
underlying stock, the put option, and the call
option.
 Ke-rT = S0 + p – c – De –rT
 Finally, one can replicate the stock through a
combination of the call option, the put option,
and a position in the risk-free asset.
S0 = c – p + Ke-rT + De –rT
1. p = –S0 + c + Ke-rT + De –rT
2. c = S0 + p – Ke-rT – De –rT
3. Ke-rT = S0 + p – c – De –rT
4. S0 = c – p + Ke-rT + De –rT
A “+” sign can be viewed as a long position
in an asset, and a “–” sign as a short or
written position in an asset.
• Also note that the relationship is valid right
now, at time 0, and thus at anytime prior to
expiration, up to and including expiration.
• At expiration, put-call parity becomes:
• p T + ST = c T + K
• where pT , ST , and CT are the payoffs at
expiration (time T) of the put option, the
stock, and the call option respectively.