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ACCA Strategic Professional · Advanced Financial Management · Application of option pricing theory in investment decisions

A European call option on a non-dividend-paying share has a market price of $14. The share price is $104, the exercise price is $110, expiry is one year away and the annual risk-free rate is 10%. Using put-call parity, what is the value of a European put with the same terms?

The put is worth $10. Put-call parity gives put = call - share price + present value of the exercise price. The present value of $110 at 10% is $100, so 14 - 104 + 100 = $10. Failing to discount the exercise price would wrongly give $20.

  1. A$10Correct
  2. B$20
  3. C$18
  4. D$31

Explanation

Parity: P = C - S + PV(X). PV(X) = 110/1.10 = 100. P = 14 - 104 + 100 = $10. Using the undiscounted exercise price gives $20, which is wrong because the exercise price is paid in one year. Adding S instead of subtracting it gives $18.

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