Put-Call Parity is a principle in options trading that states that the price of a call option, which gives the holder the right to buy an underlying asset at a specific price (the strike price), should be equal to the price of a put option, which gives the holder the right to sell the underlying asset at the strike price, minus the current price of the underlying asset.The put-call parity relationship is often expressed as a formula:Call price - Underlying asset price = Put priceIn other words, the price of a call option should be equal to the difference between the price of the underlying asset and the price of a put option on the same asset.Here's an example of how put-call parity works:Let's say the current price of a stock is $50 per share, and there is a call option with a strike price of $55 that is trading at $5 per share.There is also a put option with a strike price of $55 that is trading at $5 per share.
According to the put-call parity relationship, the price of the call option should be equal to the difference between the price of the underlying stock and the price of the put option. In this case, that would be $50 - $5 = $45.Since the actual price of the call option is $5, which is not equal to $45, there is a mispricing in the market.This mispricing creates an opportunity for an arbitrage trade, where an investor can buy the underpriced option and sell the overpriced option, locking in a profit.Put-call parity is based on the idea that the value of a call option and a put option on the same underlying asset should be equivalent, given the same strike price and expiration date. It is an important concept in options trading, as it can help investors identify mispricings in the market and potentially profit from them.
