Parity

put-call parity, as discussed on page 261 of our text, is a very important concept in options pricing. Without this parity, arbitrage opportunities would exist. The equation is as follows:

c_{0} - p_{0} = S_{0} - PV(K)

Also, the value of the call option must always abide by c_{0} ≥ S_{0} - PV(K)

An example of arbitrage is on page 263. Even with advanced pricing models used today, arbitrage opportunities may exist and allow money to be made.

The above equation can be solved to find the call premium:

c_{0} = p_{0} + S_{0} - PV(K)

Or, it can be solved to find the put premium:

p_{0} = c_{0} - S_{0} + PV(K)

page revision: 8, last edited: 18 Feb 2008 07:18