6
$\begingroup$

We know that $$C-P = PV(F_{0,T}-K)$$

When we create a synthetic forward, we buy call and sell a put at the same strike price $K$. When we buy the call why do we assume the premium is positive? When we sell the put, why do we assume the premium is negative?

|improve this question
$\endgroup$
  • $\begingroup$ You can accept one of the answers if you are satisfied by it :-) $\endgroup$ – vonjd Jan 28 '13 at 16:15
6
$\begingroup$

To see the connection between put-call parity and option price you should read this highly insightful paper by Espen Gaarder Haug & Nassim Nicholas Taleb:

Option traders use (very) sophisticated heuristics, never the Black– Scholes–Merton formula

It shows how you can heuristically derive option pricing formulas by adapting the tails and skewness by varying the standard deviation of a Gaussian - and then remove the risk parameter by using put-call parity.

Both authors are well known in the Quant-Community, they both have an academic as well as a practical background as traders.

|improve this answer
$\endgroup$
5
$\begingroup$

Both premiums are actually always positive by definition. The difference will be positive when the forward price exceeds the strike and vice versa.

|improve this answer
$\endgroup$

Your Answer

By clicking “Post Your Answer”, you agree to our terms of service, privacy policy and cookie policy

Not the answer you're looking for? Browse other questions tagged or ask your own question.