Today we will learn about put call parity and how it works,
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What is Put-Call Parity
Put-call parity is a no arbitrage principle that specifies the relationship between the price of European put options and European call options, with the same underlying asset, strike price and expiration date. Put-call parity states that simultaneously holding a short European put and long European call of the same class will deliver the same return as holding one forward (or futures) contract on the same underlying asset, with the same expiration, and a forward price equal to the option's strike price. If the prices of the put and call options diverge so that this relationship does not hold, an arbitrage opportunity would exist, meaning that arbitrage traders would be able to earn a risk-free profit. Such opportunities are uncommon and short-lived in liquid markets.
The equation expressing put-call parity is:
C + PV(x) = P + S
where:
C = price of the European call option
PV(x) = the present value of the strike price (x), discounted from the value on the expiration date at the risk-free rate
P = price of the European put
S = spot price or the current market value of the underlying asset
Put-call parity applies only to European options, which can only be exercised on the expiration date, and not American options, which can be exercised before.
Watch Patrick's other videos on covered calls and protective puts to better understand this concept.
Covered Call Video: https://www.youtube.com/watch?v=UlC9iM2Wh7I
Protective Put Video: https://www.youtube.com/watch?v=MUs4jga-NAI&t=26s
What is Put Call Parity? How does it work? put call parity formula