1
$\begingroup$

If I am long a stock $X$ which I purchased at $\$100$ and sold a covered call in the front month with strike $\$105$ for $\$2$ then is it true that the covered call is equivalent to a naked put at strike $\$100 - \$2 = \$98$?

Am I missing something here?

$\endgroup$

1 Answer 1

2
$\begingroup$

This is not quite right.

The covered call you are describing is equal to selling a Put with the same strike price (\$105) and holding ( \$105 / (1+r) ) in the bank. If you draw the Payoff diagram this will become apparent.

Put call relationships are summarized as the Put-Call parity:

$$ S - C = D \cdot K - P $$ Where $S$ the underlying, $D$ is the discount factor and $K$ the strike price.

The left side is the covered call you are describing and the right side the Put plus cash. As a bonus, using this relationship you can calculate the no arbitrage price of the put!

$\endgroup$

Your Answer

By clicking “Post Your Answer”, you agree to our terms of service and acknowledge that you have read and understand our privacy policy and code of conduct.

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