imported>Doug Williamson |
imported>Doug Williamson |
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| Put-call parity theory links put and call option values via ‘no arbitrage’ market pricing assumptions and the related:
| | TARGET2 (Trans-European Automated Real-time Gross settlement Express Transfer system) is an interbank payment system for the real-time processing of cross-border transfers throughout the EU. |
| #underlying asset price
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| #option strike price
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| #time to maturity and
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| #theoretically risk-free rate of return.
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| | Strictly speaking it is not itself a funds transfer system, rather it links existing national payment systems. |
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| So for example if the put option value, underlying asset price, strike price, time to maturity, and risk-free rate of return are known, then the call option value can be calculated using the put-call parity relationship:
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| Underlying asset price + Put value ''less'' Call value = Present Value of option strike price
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| Call value = Underlying asset price + Put value ''less'' Present Value of option strike price
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| In the special case where the strike price of the options is equal to the forward price of the underlying asset, the Put value and the Call value are exactly equal.
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| == Theoretically risk-free portfolios ==
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| The no-arbitrage pricing relationship is based on the theory that combinations of market assets and liabilities with the same terminal cash flows, must also have the same present values (i.e. the same theoretical current market prices).
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| For example both the left side and the right side of the put-call parity formula represent portfolios with the same terminal value:
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| Underlying asset + Put ''less'' Call = Present Value of option strike price
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| The left side portfolio is built by buying the underlying asset, buying a put option, and selling a call option with the same strike price.
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| The theoretically risk free terminal value of this portfolio is the equal strike price of the two options.
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| The present value of this left side portfolio is the present value of the strike price.
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| The right side portfolio is a deposit of cash.
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| This cash portfolio also produces a theoretically risk free terminal value, equal to the strike price of the options.
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| The current market pricing of these two portfolios must in theory be exactly the same.
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| If this relationship did not hold, there would be an arbitrage opportunity to buy the cheaper portfolio and sell the more expensive one, to earn an immediate risk free profit.
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| Therefore market supply and demand pressures will act to quickly re-establish the no arbitrage pricing relationship, following any temporary pricing mis-alignments.
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| | ''TARGET2 is the successor to the earlier TARGET payment system.'' |
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| == See also == | | == See also == |
| * [[Arbitrage]] | | * [[Trans-European automated real-time gross settlement express transfer]] |
| * [[Interest rate parity]]
| | * [[Gross settlement system]] |
| * [[Option]] | | * [[ISO 20022]] |
| * [[Parity]] | | * [[Payments and payment systems]] |
| * [[Put option]] | |
| * [[Risk-free rate of return]]
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| [[Category:Corporate_financial_management]] | | [[Category:Cash_management]] |
| [[Category:Financial_risk_management]]
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