The stock component of the married put could be purchased on margin.
Buying stock on margin is borrowing capital to finance a stock purchase.
This means the trader has to pay interest on these borrowed funds. Even if
the stock is purchased without borrowing, there is opportunity cost
associated with the cash used to pay for the stock. The capital is tied up. If
the trader wants to use funds to buy another asset, he will have to borrow
money, which will incur an interest obligation. Furthermore, if the trader
doesn’t invest capital in the stock, the capital will rest in an interest-bearing
account. The trader forgoes that interest when he buys a stock. However the
trader finances the purchase, there is an interest cost associated with the
transaction.
Both of these positions, the long call and the married put, give a trader
exposure to stock price advances above the strike price. The important
difference between the two trades is the value of the stock below the strike
price—the part of the trade that is not at risk in either the long call or the
married put. On this portion of the invested capital, the trader pays interest
with the married put (whether actually or in the form of opportunity cost).
This interest component is a pricing consideration that adds cost to the
married put and not the long call.
So if the married put is a more expensive endeavor than the long call
because of the interest paid on the investment portion that is below the
strike, why would anyone buy a married put? Wouldn’t traders instead buy
the less expensive—less capital intensive—long call? Given the additional
interest expense, they would rather buy the call. This relates to the concept
of arbitrage. Given two effectively identical choices, rational traders will
choose to buy the less expensive alternative. The market as a whole would
buy the calls, creating demand which would cause upward price pressure on
the call. The price of the call would rise until its interest advantage over the
married put was gone. In a robust market with many savvy traders,
arbitrage opportunities don’t exist for very long.
It is possible to mathematically state the equilibrium point toward which
the market forces the prices of call and put options by use of the put-call
parity. As shown in Chapter 2, the put-call parity states