Basic Module 6 – Put-Call Parity

Open a virtual trading account to practice what you pick up in each module

Introduction / Learning Outcomes:

Kevin Cook takes you through the foundation of options trading – put-call parity. Kevin answers the question, “Where does the arb opportunity end and logical, fair pricing begin again?” Kevin discusses how puts and calls make up a whole and how puts and calls trade in lock-step. Specifically, you shall learn:

1. What arbitrage means.
2. How arbitrage helps determine fair option prices.
3. Characteristics of an arbitrage trader.
4. How a put and a call make up a whole.
5. How multi-purpose combinations are different from pointless combinations.
6. How multi-purpose combinations allow an options investor to go in both directions for the underling equity.
7. How to replicate a long-stock.
8. How to replicate a short-stock.
9. How puts and calls are locked-in step with regards to their prices.
10. What happens to options when they trade out of line with their fundamental relationships.
11. When it is arbitrage trades become unprofitable.
12. Why options have a built-in interest rate component.

Recommended Exercises:

1. Compare the profit/loss graph of a long stock to the profit/loss graph of selling a stock short.
2. Replicate a long stock’s profit/loss graph.
3. Replicate a short stock’s profit/loss graph.

Calculate the built-in interest rate component for an option.