Put-Call Parity is a fundamental concept in options pricing, establishing the relationship between European put and call options. It ensures that the combined value of a call option and the present value of the strike price equals the value of a put option and the stock price, preventing arbitrage. This principle is vital for financial strategies, trading, and corporate finance, as it aids in hedging and fair valuation of options, including adjustments for dividends.
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Put-Call Parity is a principle in financial economics that defines the relationship between the prices of European put and call options
Identical strike prices and expiration dates
Put-Call Parity states that put and call options with identical strike prices and expiration dates should have a specific relationship
Combined value of options
According to Put-Call Parity, the combined value of a long call option and the present value of the strike price should be equal to the combined value of a long put option and the current stock price
The formula for Put-Call Parity is C + PV(X) = P + S, where C is the call option price, P is the put option price, S is the spot price of the underlying stock, X is the strike price, and PV(X) is the present value of the strike price
Put-Call Parity is a critical concept in corporate finance, used to devise hedging strategies and ensure options are fairly valued
Dividends play a significant role in the Put-Call Parity model, requiring adjustments to the formula to accurately value options on dividend-paying stocks
Arbitrage is a key mechanism in enforcing Put-Call Parity in efficient markets, correcting any misalignments in option prices
The Put-Call Parity equation is a cornerstone of derivatives pricing theory, derived from the law of one price and used in financial decision-making
Put-Call Parity is used to determine the fair value of options in the financial industry
Put-Call Parity can be used to create synthetic positions, such as a synthetic long position in a foreign currency
While primarily applicable to European options, Put-Call Parity can be adapted for American options by considering the early exercise feature
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Put-Call Parity formula components
C + PV(X) = P + S; C=call price, PV(X)=present value of strike, P=put price, S=stock price.
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Put-Call Parity application
Used to identify mispricing, arbitrage opportunities, and fair valuation of options.
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Put-Call Parity condition
Applies to European options with same strike price and expiration.
