loader2
Partner With Us NRI

Open Free Demat Account Online with ICICIDIRECT

Understanding Put and Call Parity and How They Work

Introduction

Options contracts are Derivatives where the buyer has the right to purchase or sell an underlying asset but is not legally obligated to do so. Put and Call parity is the mathematical principle determining the relationship between the Price of Put Options and Call Options. Put and Call parity first appeared in the Middle Ages and was referred to in the following ages by various scholars such as Nelson in 1904, Vincenz Bronzin in 1908, Henry Deutsch in 1910. These scholars’ works have only recently been rediscovered. The first modern introduction to Put and Call parity was by the economist Hans R. Stoll in his paper, “The Relationship Between Put and Call Option Prices,” published in The Journal of Finance in 1969.

Put and Call parity

The Put and Call parity determines the relationship between Put Options and Call Options of the same category, i.e., those Put and Call Options with the same underlying assets and whose expiration dates and Strike Prices are identical. The Put and Call parity applies only to European-style Options, which can only be exercised on the date of expiration. Put and Call Options to help determine the arbitrage opportunities from the entirety of the Options contract.

The working of Put and Call parity

The Put and Call parity assumes that the value of the Put Options and the value of the Call Options with the same underlying assets cancel each other out, thereby achieving a zero-value parity for the investors. The Put and Call parity is expressed by the equation C + PV(x) = P + S where:

C = Price of Call Options

PV(x) = Present value of Strike Price (x)

P = Price of Put Option

S = Spot Price, i.e., the present value of the underlying asset.

This basis equation is modified to find the value of more complex variations of the Put and Call parity.

Meaning of Put and Call Parity

Put and Call parity means that both Put Options and Call Options with the same underlying asset can be used for the same goal in a portfolio. It also means that the implied volatility of an underlying asset is the same for both Put Options and Call Options.

Importance of the Put and Call parity

Put and Call parity is helpful for investors who want to protect themselves from price fluctuations in the markets since it allows for the calculation of investment required to offset Put and Call Options. That is also useful for speculators since the same equation allows for the analysis of arbitrage opportunities. The Put and Call parity is also important in the valuation of Options and understanding how market forces affect the pricing of Options. It also helps in understanding the relationship between Options pricing and the Price of the underlying assets.

Conclusion

The Put and Call parity remains an integral part of any attempt at an overall understanding of the pricing of Options and related strategies. Its simplicity is both an advantage as well as a disadvantage. While it allows for the knowledge of the basic Options contracts and their pricing, it can underperform when dealing with complex variations of Options. Such complex variations are better analysed through models, such as the Black-Scholes method and the Monte Carlo method.

Disclaimer

ICICI Securities Ltd. ( I-Sec). Registered office of I-Sec is at ICICI Securities Ltd. - ICICI Centre, H. T. Parekh Marg, Churchgate, Mumbai - 400020, India, Tel No : 022 - 2288 2460, 022 - 2288 2470. The contents herein above shall not be considered as an invitation or persuasion to trade or invest.  I-Sec and affiliates accept no liabilities for any loss or damage of any kind arising out of any actions taken in reliance thereon. The contents herein above are solely for informational purpose and may not be used or considered as an offer document or solicitation of offer to buy or sell or subscribe for securities or other financial instruments or any other product. Investments in securities market are subject to market risks, read all the related documents carefully before investing. The contents herein mentioned are solely for informational and educational purpose.

Most Popular

  • 13 May 2022
  • ICICI Securities

The Five-Point Financial Planning Checklist For Your Family

Whether you just got married or planning to have a baby or have dependents, you should have financial plans for every stage in your life to ensure a secured future for your family members. Here are five things you can do financially for your family.   

  • 12 May 2022
  • ICICI Securities

What is a Zero Coupon Bond?

You get fixed returns in the form of interest until maturity when you invest in a bond. Zero-coupon bonds work a little differently. In this article, find out what zero-coupon bonds are, their advantages and whether you should invest in them. 

  • 12 May 2022
  • ICICI Securities

What are Cross Currency Pairs?

The forex market is the largest financial market globally. Currency trading is a lucrative and booming business. While most currencies trading happens in relation to the US Dollar, some don’t. That forms the basis of cross currency pairs. Here’s what you need to know about it. 

  • 12 May 2022
  • ICICI Securities

Investing principles from Benjamin Graham: The Father of Value Investing

Benjamin Graham was a British born economist, professor, and investor who taught at Columbia University. He was also a mentor to some of the most famous investors of the 20th century, including Irving Khan, John Templeton, & Warren Buffett. Buffett called him "the second most influential figure in his life, only after my father". 

  • 12 May 2022
  • ICICI Securities

How to Invest in Nifty 50?

The Nifty 50 is the benchmark index of the National Stock Exchange. It represents the 50 largest companies listed in India. Investing in the Nifty 50 can be a good idea for those looking to make index-linked returns. Here’s how you can invest in the index. 

  • 12 May 2022
  • ICICI Securities

Investment philosophy of Cathie Wood: The most powerful woman on Wall Street

Catherine Duddy Wood, also called Cathie Wood, is an investor who primarily invests in disruptive technologies and is the founder, chief executive officer, and chief investment officer of ARK Investment Management, LLC, an investment management firm mostly active in the United States.

  • 11 May 2022
  • ICICI Securities

How to Use Technology to Improve Your Finances

Technology has made life simpler for everyone. In the realm of personal finance, technology has streamlined many processes—from budgeting to automating your payments. On National Technology Day, let’s look at how technology has transformed our finances. 

  • 11 May 2022
  • ICICI Securities

How to Invest in your Every Goal with Mutual Funds?

Each of us is unique. We have different needs and goals in life. Some of us can ride along swinging markets, while some may need a relatively conservative investment tool. 

  • 11 May 2022
  • ICICI Securities

Four Reasons Why Entrepreneurs should Invest in Equity Mutual Funds

Equity mutual funds provide growth opportunities not just for individual investors but also for entrepreneurs and corporates. They make excellent investments for anyone looking for wealth creation. This article will give you four reasons why businesspeople should consider investing in equity mutual funds.