What is Put-Call Parity?
Put-call parity refers to the relationship between put and call options for a given security, strike price and expiration date. Under put-call parity, the option prices should match, yielding no profit or loss.
How Does Put-Call Parity Work?
In theory and in practice, the risk/return relationship between puts and calls on the same security should be identical. For example, a long call (i.e., an option purchase that assumes that the price will go up) has the same risk/return (and therefore, price) as a short put (i.e., an option purchase that assumes that the price will go down). The following table illustrates the balance or parity between puts and calls on the same option.
Why Does Put-Call Parity Matter?
Put-call parity is a common test for option spread strategies, assuming that the long and short positions will provide a hedge against risk. If an option does not show parity, then it provides the opportunity for gains.