30 lines
2.0 KiB
Plaintext
30 lines
2.0 KiB
Plaintext
But the change makes sense intuitively, too, when a call is considered as a
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cheaper substitute for owning the stock. For example, compare a $100 stock
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with a three-month 60-strike call on that same stock. Being so far ITM,
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there would likely be no time value in the call. If the call can be purchased
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at parity, which alternative would be a superior investment, the call for $40
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or the stock for $100? Certainly, the call would be. It costs less than half as
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much as the stock but has the same reward potential; and the $60 not spent
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on the stock can be invested in an interest-bearing account. This interest
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advantage adds value to the call. Raising the interest rate increases this
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value, and lowering it decreases the interest component of the value of the
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call.
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A similar concept holds for puts. Professional traders often get a short-
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stock rebate on proceeds from a short-stock sale. This is simply interest
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earned on the capital received when the stock is shorted. Is it better to pay
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interest on the price of a put for a position that gives short exposure or to
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receive interest on the credit from shorting the stock? There is an interest
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disadvantage to owning the put. Therefore, a rise in interest rates devalues
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puts.
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This interest effect becomes evident when comparing ATM call and put
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prices. For example, with interest at 5 percent, three-month options on an
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$80 stock that pays a $0.25 dividend before option expiration might look
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something like this:
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The ATM call is higher in theoretical value than the ATM put by $0.75.
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That amount can be justified using put-call parity:
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(Here, simple interest of $1 is calculated as 80 × 0.05 × [90 / 360] = 1.)
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Changes in market conditions are kept in line by the put-call parity. For
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example, if the price of the call rises because of an increase in IV, the price
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of the put will rise in step. If the interest rate rises by a quarter of a
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percentage point, from 5 percent to 5.25 percent, the interest calculated for
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three months on the 80-strike will increase from $1 to $1.05, causing the |