Investments, tenth edition

 Table 20.5 

 Arbitrage 

strategy 

Immediate 

Cash Flow

Cash Flow in 1 Year

Position

S

T

* 105

S

T

# 105

Buy stock

2

110

S

T

S

T

Borrow $105/1.05 5 $100

1

100

2

105

2

105

Sell call

1

17

0

2

(S

T

 2 105)

Buy put

2

5

105 2 S

T

0

 TOTAL

2

0

0

 Let’s see how well parity works using the data in  Figure 20.1  on the IBM options. The 

February expiration call with exercise price $195 and time to expiration of 28 days cost 

$3.65 while the corresponding put option cost $5. IBM was selling for $194.47, and the 

annualized short-term interest rate on this date was 0.1%. IBM was expected to pay a 

dividend of $.85 with an ex-dividend date of February 8, 18 days hence. According to 

parity, we should find that   

P 5 C 1 PV(X) 2 S

0

 1 PV(Dividends)

5.00 5 3.65 1 

195

(1.001)

28/365

 2194.47 1 

.85

(1.001)

18/365

5.00 5 3.65 1 194.985 2 194.47 1 .85

5.00 5 5.015  

 So parity is violated by about $.015 per share. Is this a big enough difference to exploit? 

Almost certainly not. You have to weigh the potential profit against the trading costs of 

the call, put, and stock. More important, given the fact that options trade relatively infre-

quently, this deviation from parity might not be “real,” but may instead be attributable 

to “stale” (i.e., out-of-date) price quotes at which you cannot actually trade. 

 Example  20.6 

Put-Call Parity 

bod61671_ch20_678-721.indd   700

bod61671_ch20_678-721.indd   700

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7/25/13   2:50 AM

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  C H A P T E R  

2 0

  Options Markets: Introduction 

701

    20.5 

Option-Like Securities 

  Suppose you never traded an option directly. Why do you need to appreciate the properties 

of options in formulating an investment plan? Many financial instruments and agreements 

have features that convey implicit or explicit options to one or more parties. To value and 

use these securities correctly, you must understand their embedded option attributes.