lecture3spr07

Put-Call Parity: 

Put-Call Parity

Think Question??: 

Think Question?? Suppose the futures and options markets for May-07 KCBT Wheat are trading at the following prices: May-07 Wheat Futures: 505 cents May-07 Wheat 500 Call Option: 6 cents May-07 Wheat 500 Put Option: 4 cents   Can you take a position in these markets to make a risk-free profit at expiration? Describe your position in each market and compute the expected profit at expiration of the options. Hint: your position will involve the futures, call and put market.

Buy 300 Call Option for 6:Profit/Loss at Expiration: 

Buy 300 Call Option for 6: Profit/Loss at Expiration

Sell 300 Put Option for 4:Profit/Loss at Expiration: 

Sell 300 Put Option for 4: Profit/Loss at Expiration

Buy 300 Call Option for 6+ Sell 300 Put Option for 4:: 

Buy 300 Call Option for 6 + Sell 300 Put Option for 4:

Buy 300 Call Option for 6+ Sell 300 Put Option for 4: 

Buy 300 Call Option for 6 + Sell 300 Put Option for 4 ‘Synthetic’ Long Futures Position at 302 502 = Strike + Call Prem – Put Prem

Sell Futures at 305: 

Sell Futures at 305

Sell Futures at 305: 

Sell Futures at 305 Long (Synthetic) Futures at 302

Long Call + Short Put + Short Futures: 

Long Call + Short Put + Short Futures Guaranteed 3 Cent Profit

PUT-CALL PARITY: 

PUT-CALL PARITY Call Premium – Put Premium = Futures Price – Strike Price Applies to calls and puts with the same strike price only.

May-07 Wheat CBT OptionsMay Futures 487.5: 

May-07 Wheat CBT Options May Futures 487.5

Implication of Put-Call Parity: 

Implication of Put-Call Parity Any Two Positions Can Make A Third! EXAMPLES: Short Futures + Long Call = Long Put Long Futures + Long Put = Long Call

Hedging Example 1: 

Hedging Example 1 Mar 1: Sell Sep-07 KCBT Wheat Futures @ 535 to hedge New-Crop Wheat Production Mar 31: Bullish Acreage Intentions Report Apr 1: Sep-07 Futures = 510 (+25 cent profit) Buy a 520 Call Option for 18 => Long a 520 Put at –7 premium

Hedging Example 2: 

Hedging Example 2 Mar 1: Forward Contracted Grain Mar 31: Bullish Acreage Intentions Report Apr 1: Want to re-own the grain with a 500 Sep-03 Call Option (not traded) Buy a 500 Put for 14 Buy Futures at 510 =>Long a ‘Synthetic’ 500 Call @ ????? (C-P) = (F-S) Or, C = (F-S) + P = 24 cents

Put-Call Parity Summary: 

Put-Call Parity Summary Guarantees No-Arbitrage Equilibrium Prices Between Calls, Puts and Futures Can Create a ‘Synthetic’ position from two other assets.