Put-Call Parity for European Options
If we compare the outcome from a portfolio created by combining long positions inthe security with a put option and a short position in the call option, both withExercise price 'X' and expiry period 't,' if at expiration:
Value diagram ( y -axis)
ShareSharePut OptionX S
XShare priceWritten call option(i) S > = XShare = SPut Option = 0Written Call option = - (S-X)Value of portfolio = X(ii) S <= XShare = SPut Option = x-SWritten Call option = 0Value of portfolio = XSo in all cases, the value of the portfolio at expiry is 'X.' This in turn implies that thevalue of the portfolio so constructed at the beginning of the period must also be
S + P-C = PV(X) = X e
(alternatively =x/(1 + rf. t)
This is the no-arbitrage condition and implies that a Portfolio made up of a long position in the share, with a put option and a short position in the call option, bothwith Exercise price 'X' and expiry period 't,' is a riskless hedge portfolio, with thesame outcome at expiry as an investment in a risk-free bond which matures to a valueX at expiry.