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Put-Call Parity

July 19, 2012
  • Stock + Put = Bond + Call
  • Negative value for Bond means you’re borrowing money
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From → Asset Valuation

3 Comments
  1. Kriste permalink

    Can you tell me what you meant by putting the – sign before “Bond means…”?

    I’m having trouble understanding put/call parity. 😦

  2. You have to remember that a stock plus a put has to equal the call plus a bond. Sometimes given the value of the stock, the value of the put, and the value of the call the only way to make the equation work is for the bond to have a negative value. If the bond has a negative value that means you’re borrowing money.

    It is just a second bullet point on the card to remind you that a negative value for the bond is possible. You need to memorize the formula but you may be give real numbers in which case it can become an algebra question. Stocks can only go as low as zero, same with options they can be worthless but for the equation to work in all situations the bond value can be negative.

    Here’s a video with the accompanying diagrams but it doesn’t go into detail about what a negative value for the bond means. Sometimes you just have to accept something as a fact and memorize it.

    http://www.khanacademy.org/science/core-finance/derivative-securities/put-call-options/v/put-call-parity-clarification

    I prefer to memorize the formula this way: stock + put = bond + call, a nice formula with no negative signs but generally you have to solve for something say the value of the put = bond + call – stock or the call = stock + put – bond etc. etc.

    I added the extra note to remind myself when doing the questions that a negative value for the bond was not a mistake.

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