Options parity theorem, Put Call Parity
Andrew Hecht Updated March 24, Options are derivative instruments. One of the reasons that option trading and investing is so much fun is that is it like a game of chess. During the life of an option, there are so many opportunities that will enhance or destroy the value of a position. There are so many moving pieces in the puzzle of options trading.
The nominal option prices move higher or lower as implied volatility can move up or down and supply and demand for options themselves will move option premiums. What Is Put-Call Parity? Is it profitable to buy bitcoin parity is a concept that anyone involved in options markets needs to understand.
Parity is a functional equivalence.
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- Options: The Concept of Put-Call Parity
The genius of option theory and structure is that two instruments, puts, and calls, are complementary with respect to both pricing and valuation. Therefore, by knowing the value of a put option you can quickly calculate the value of the complimentary call option with the same strike price and expiration date.
There are many reasons that this is important knowledge for traders and investors. It can highlight profitable opportunities that present themselves when option premiums are out of whack. Understanding put-call parity can also help you to gauge the relative value of an option you may be considering for your portfolio.
There are two styles of options: American and European. The exercise of American options can be options parity theorem any time during their life while the exercise of European options only occurs on the options' expiration date. Options parity theorem, put-call parity only works perfectly with European style options.
PUT CALL PARITY THEORY
Option premiums have two components: intrinsic value and time value. Intrinsic value is the in-the-money portion of the option.
Time value represents the value of the option attributed exclusively to time. Therefore, in-the-money options have both intrinsic and time value while an out-of-the-money option has only time value.
This arbitrage opportunity involves buying a put option and a share of the company and selling a call option.
Put-call parity is an extension of these concepts. As you might imagine, call and put options that are at-the-money strike prices equal to the current futures price with the same expiration and strike price straddles will trade at the same price as both only have time value. Options are amazing instruments. Understanding options and put-call parity will enhance your market knowledge and open new doors of profitability and risk management for all of your investment and trading activities.
Put-call parity is an attribute of options markets that is applicable not only in commodities but in all asset markets where options markets thrive. Spend some time and understand put-call parity as it is a concept that will put you in a position to understand markets better than most other market participants giving you an edge over all competition.
Success in markets is often the result of the ability to see market divergence or mispricing before others.
Understanding the Put Call Parity relationship can help you connect the value between a call option, a put option and the stock. When you see how these building blocks are connected, you will be able to create other synthetic positions using various option and stock combinations. The original formula provides the basis and we'll take a look later in the article how to account for American style stock options that pay dividends.
The more you know, the better the chances of success.