COMP 7570- Computational Finance

10.4 PUT-CALL PARITY

Avardeep Singh
Department of Computer Science
University Of Manitoba

Assumptions
S0: Current Stock Price
K: Strike Price of Option
T: Time of expiration of option
ST: Stock Price on the expiration date
r: continuously compounded risk-free rate of interest for
an investment maturing in time T (r>0)

Contd
C: Value of American Call option to buy one share
P: Value of American Put option to sell one share
c: Value of European Call option to buy one share
p: value of European put option to sell one share

Put-call parity
Works on European Options
Underlying asset in Put and Call option is same i.e. stock
Expiry of Call=Expiry of Put
Zero-Coupon Bond= Present value of Strike Price
discounted @ risk free rate
Strike Price of Call= Strike Price of Put

Contd
Portfolio A = one European call option + Zero-coupon
Bond that provides a payoff K at time T
Portfolio C= One European Put option + one share of
the stock.
Assumption: Stock pays No dividend.

Contd

Contd
If ST > K , both portfolio worth is ST
If ST < K, both portfolio worth is K
In short, Both are worth - max(ST , K)

Contd
Components of Portfolio A are worth c + K
Components of portfolio B are worth p+S0
Hence,
c + K =p+S0
The above relationship is known as put-call parity

Example
Spot Price
at time 0

ST+ p

B+c

200

200+0

100 + 100

180

180+0

100 + 80

100

100+0

100 + 0

70

70+30

100 + 0

0+100

100 + 0

K=100

American Options
Put-call parity usually holds for European options
But we can derive some result for American Options
prices when there are no dividends
(S0 K) <= (C P) <= (S0 K )

Example
K= $20.00
T= 5 Months
C= $1.50
ST= $19.00
R=10 %
(19 - 20) <= (C-P) <= (19 20)
1 >= P-C >= 0.18

Contd
P C lies between $1.00 and $0.18
With C at $1.50, P must lie between $1.68 and $2.50