Question

1. What's put-call parity? Please explain it.

2. What's a protective put?

Answer 1

1. First of all Put-call parity applies only to European options, which can only be exercised on the expiration date, and not American options, which can be exercised before.

It is a principle that defines the relationship between the price of European put options and European call options of the same class,that is, with the same underlying asset, strike price and expiration date.

It can be understood as a combination of both the options which is call and put with the same strike price and same duration and same underlying asset.

The Equation of Put-Call parity is : C + PV(x) = P + S

where, C = price of the European call option, PV(x) = the present value of the strike price (x), discounted from the value on the expiration date at the risk-free rate, P = price of the European put, S = spot price or the current market value of the underlying asset

2. A protective put is a risk-management strategy that investors can use to guard against the loss of unrealized gains in a stock or other asset.

In simple words Protective puts involve being long a stock and purchasing put options for that stock with a strike price that is near the underlying stock's current price.

The notation would be Protective put:(S⁺,P⁺), where S⁺,P⁺ are Buying a stock at market price and buying a put option on strike price, this way we can enjoy the benefit of uppward movement of stock and also save ourselves from the downward movement of stock since put option is excercised.