Corporate Finance

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Corporate Finance

Cash Distributions (Dividend)

A cash dividend paid on the stock decreases the stock price because of which the call option value declines.
The opposite is true for a put option because a fall in stock price increases the value of a put option.
Exhibit 12.1(b) is a summary of the effect of each factor on option value.

Exhibit 12.1(b) The impact of factors determining option value

Variable Call Put

Asset price ↑↓
Exercise price ↓↑
Maturity ↑?
Volatility ↑↑
Interest rates ↓↑
Dividends ↓↑

PUT–CALL PARITY

Consider again the ACC stock option illustrated earlier. The options—put and call—have identical strike
price and maturity date written on the same underlying asset: the ACC stock. Since the options have identical
characteristics we would expect them to be related in some way. There is a condition known as put–call
parity that describes the relation between the call and put option values.
Assume that you have purchased a European call option and sold a European put option on the same
asset (S) with the same exercise price X and expiration date. The investment required to establish this position
is the difference between call and put values.
That is, C–P
The pay off to this position is S–X. On the expiration date if the spot price is less than the expiration price,
the call option expires worthless and the put option will be exercised against the position. Consequently, the
payoff will be negative.
Consider another investment in which an investor borrows the present value of X to purchase the asset.
The investment required is:

rT

X

S

1(+ )

=

And the payoff to this position on the expiration date, T, is S–X since the investor owns the asset (S) and
owes X.
Since the payoff to these two investment positions is the same their initial investment must also be the
same to prevent arbitrage opportunities.^1

rT

X

SPC

+ )1(

−=−

(^1) A standard text on derivatives would explain put–call parity in greater detail. Refer to Hull, for example.