Call Put Parity :
The meaning of call-put parity is that the prices of the call & put should move as per their justified ratio in combination of the underlying security.
To understand it in a practical manner lets take an example :-
Nifty is trading at Rs.6000/-
Nifty call ( strike 6000 ) is trading at 120/-
Nifty put ( strike 6000 ) is trading at 120/-
Now the nifty price moves up by Rs.20 and the prices of the above call and put moves accordingly :-
Nifty price now : 6020/-
Nifty call price ( 6000 ) now 128/- from 120 ( difference Rs.8 )
Nifty put price ( 6000 ) now 108/- from 120 ( difference Rs.12 )
From the above, it seems that the prices of the put ( 6000 ) strike went down by Rs.4/- more then the price of the call moved up, while the above prices are right according to call –put parity.
Lets assume that the price of the put also moved down to Rs.112 ( Rs. 8 difference at par with the price move of the call ).
If the above situation arises, it brings the opportunity for the risk free arbitrage , see how it can be riskfree :
Nifty price moved from 6000 to 6020/-
Nifty call ( 6000 strike ) moves from 120 to 128/-
Nifty Put ( 6000 strike ) moves from 120 to 112/-
In this situation, we will sell put 6000 at Rs.112/-
Sell nifty future at 6020/-
Buy nifty call ( 6000 strike ) at 128/-
Now , lets see how it becomes the riskfree arbitrage :
We assume that the nifty expires at 6020/-
Then the profit and loss in the above three should be as under :-
Nifty bought at 6020, sold at 6020 ( no loss, no profit )
Nifty call bought at 128 , sold at 20 ( loss of 108 )
Nifty put sold at 112, bought at zero ( as nifty expires above 6000 ) ( making a profit of 112)
Hence profit 112-loss 108 = Rs.4/- profit.
So from the above equations, we got riskfree profit of Rs.4/- per unit, making a total profit of Rs.200/- on one lot of the spread.
(We also do care for the brokerage which we will have to bear in the above case. )
We have made such type of arbitrage advanced. We do arbitrage index with stock in the above manner and for more points. Thus we don’t not have to worry about the brokerage as we are getting more points in the advanced arbitrage of index with stocks options.
Thanks.
