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Put-Call Parity Explained for CFA Level 1

The document explains option replication using put-call parity for European options, detailing the derivation and relationships between protective puts, fiduciary calls, and their payoffs. It provides a formula for put-call parity and an example calculating the value of a call option based on given stock and option prices. Additionally, it introduces put-call-forward parity, which relates forward contracts to option pricing.

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6 views3 pages

Put-Call Parity Explained for CFA Level 1

The document explains option replication using put-call parity for European options, detailing the derivation and relationships between protective puts, fiduciary calls, and their payoffs. It provides a formula for put-call parity and an example calculating the value of a call option based on given stock and option prices. Additionally, it introduces put-call-forward parity, which relates forward contracts to option pricing.

Uploaded by

harsoftware3
Copyright
© All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd

Derivatives

Derivatives

Option Replication Using


Put-Call Parity

LOS a Explain Option Replication Using Put-Call Parity

Deriving Put-Call Parity


(European Options)
Protective put = stock + put
X
If S ≤ X, payoff = S + (X – S) = X
0
If S ≥ X, payoff = S + 0 = S X

© Kaplan, Inc. 2

1
LOS a Explain Option Replication Using Put-Call Parity

Deriving Put-Call Parity


(European Options)
Fiduciary call = call + X / (1 + Rf)T
(bond that pays X at maturity)

If S ≤ X, payoff = 0 + X = X X
If S ≥ X, payoff = (S – X) + X = S 0
X
Same payoffs means same values by no-arbitrage
Put-call parity: S + P = C + X / (1 + Rf)T

© Kaplan, Inc. 3

LOS a Explain Option Replication Using Put-Call Parity

Option Replication
X
S+P=C+ can be rearranged
(1+R f )T
X
to get P = C – S +
(1+R f )T
X
and C = P + S –
(1+R f )T

© Kaplan, Inc. 4

2
LOS a Explain Option Replication Using Put-Call Parity

Put-Call Parity Example


A stock is priced at $52 and Rf = 5%. A 3-month put option on the
stock with an exercise price of $50 is valued at $1.50. What is the
value of a
3-month call option with an exercise price of $50?

X 50.00
C =P + S – T = 1.50 + 52.00 – = $4.11
(1+R f ) (1.05)0.25

© Kaplan, Inc. 5- 3

LOS b Explain Option Replication Using Put-Call Parity

Put-Call-Forward Parity
We can replicate the underlying asset with a forward contract and a
risk-free bond that pays the forward price at expiration:
S0 = F0(T) / (1 + Rf)T

Same relationships hold:


Put-call parity: S + P = C + X / (1 + Rf)T
Put-call forward parity:
F0(T) / (1 + Rf)T + P = C + X / (1 + Rf)T

© Kaplan, Inc. 6

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