23 lines
1.2 KiB
Plaintext
23 lines
1.2 KiB
Plaintext
287
|
||
Appendix c
|
||
PUT-cALL PArITy
|
||
Before the Black-Scholes-Merton model (BSM), there was no way to
|
||
directly calculate the value of an option, but there was a way to triangulate
|
||
put and call prices as long as one had three pieces of data:
|
||
1. The stock’s price
|
||
2. The risk-free rate
|
||
3. The price of a call option to figure the fair price of the put, and vice
|
||
versa
|
||
In other words, if you know the price of either the put or a call, as long
|
||
as you know the stock price and the risk-free rate, you can work out the
|
||
price of the other option. These four prices are all related by a specific rule
|
||
termed put-call parity.
|
||
Put-call parity is only applicable to European options, so it is not ter-
|
||
ribly important to stock option investors most of the time. The one time it
|
||
becomes useful is when thinking about whether to exercise early in order
|
||
to receive a stock dividend—and that discussion is a bit more technical. I’ll
|
||
delve into those technical details in a moment, but first, let’s look at the big
|
||
picture. Using the intelligent option investor’s graphic format employed in
|
||
this book, the big picture is laughably trivial.
|
||
Direct your attention to the following diagrams. What is the differ -
|
||
ence between the two? |