Appendix C: Put-Call Parity   • 291
acts as a “negative drift” term in the BSM. When a dividend is paid, theory 
says that the stock price should drop by the amount of the dividend. Be-
cause a drop in price is bad for the holder of a call option, the price of a call 
option is cheaper by the amount of the expected dividend.
Thus, for a dividend-paying stock, to establish an option-based position 
that has exactly the same characteristics as a stock portfolio, we have to keep 
the expected amount of the dividend in our margin account.
1 This money 
placed into the option position will make up for the dividend that will be 
paid to the stock holder. Here is how this would look in our equation:
C
K − PK + (K − Int) + Div = S
With the dividend payment included, our equation is complete.
Now it is time for some algebra. Let’s rearrange the preceding equa-
tion to see what the call option should be worth:
CK = PK + Int − Div + (S − K)
Taking a look at this, do you notice last term (S  – K )? A stock’s price 
minus the strike price of a call is the intrinsic value. And we know that 
the value of a call option consists of intrinsic value and time value. This 
means that
/dncurlybracketleft/dncurlybracketmid/horizcurlybracketext/horizcurlybracketext/dncurlybracketright/horizcurlybracketext/horizcurlybracketext/dncurlybracketleft/dncurlybracketmid/dncurlybracketright=+ −−CP SKKK IntD iv + ()
Time valueI ntrinsic value
So now let’s say that time passes and at the end of the year, the stock 
is trading at $70—deep ITM for our $50-strike call option. On the day 
before expiration, the time value will be very close to zero as long as the op-
tion is deep ITM. Building on the preceding equation, we can put the rule 
about the time value of a deep ITM option in the following mathematical 
equation:
P
K + Int − Div ≈ 0
If the time value ever falls below 0, the value of the call would trade for less 
than the intrinsic value. Of course, no one would want to hold an option 
that has negative time value. In mathematical terms, that scenario would 
look like this:
P
K + Int − Div < 0