Put-call parity is the link between the prices of a call and a put with the same strike and expiry. If it breaks, traders can lock in a risk-free profit, so in liquid markets it holds closely.
The formula
For European options on an underlying with no dividends: Call – Put = Spot – present value of Strike. The present value is the strike discounted at the risk-free rate until expiry.
Example
Spot is 100, the strike is 100, there are three months to expiry and interest rates are 6 percent. The present value of the strike is about 98.51, so the call should trade about 1.49 above the put.
Why it is useful
- It explains why ATM calls usually cost a little more than ATM puts.
- It shows that a long call plus a short put behaves like a long future.
- If one side looks mispriced, check dividends, interest rates and liquidity before assuming an opportunity.
This article is for education only and is not financial advice. Options involve risk and are not suitable for every investor.