Put-call parity derives from an equal-payoff portfolio construction.
Evidence
- Consider, for example, these two positions on a stock that pays no dividends: (a) a call option with a strike price equal to the current stock price, plus cash equivalent to the stock price; and (b) buying the stock in question plus a put with the same strike price as the call. (The call and the put have the same expiration date, and both are European: they can be exercised only at their expiration.) The payoff of the two positions is equal. If the stock price rises above the strike price, the payoff from exercising the call is just the stock’s gain in price, while if the stock price falls below the strike price, exercise of the put eliminates the loss on the stock. Factoring in the capacity to earn interest on the cash yields a simple equation connecting put and call prices. — Donald MacKenzie, An Engine, Not a Camera, 1565
Categorization
- DEFINE: A compact demonstration of the put-call parity construction underlying the derivatives chapter’s argument.
- XREF: connects to: Exchange market microstructure determines how well put-call parity prices are maintained. — Donald MacKenzie, An Engine, Not a Camera: How Financial…, 756