CFA Level I · CFA Level I Exam · Option Replication Using Put-Call Parity
An investor holds a share and buys a European put on it with the same expiration. At expiration, the share price is below the exercise price. The payoff of this protective put position is most likely:
The payoff is the exercise price. When the share price ends below the strike, the put pays the difference between the strike and the share price, and adding the share value gives exactly the strike. The premium affects profit, not payoff.
- Aequal to the share price
- Bequal to the exercise priceCorrect
- Cequal to the exercise price minus the put premium
Explanation
If S_T is below X, the share is worth S_T and the put pays X - S_T, so the total is X. The premium was paid at inception and is not part of the payoff at expiration (it affects profit, not payoff). The share price alone ignores the put payoff.
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