Reference no: EM131324409
Put-call parity is a powerful formula that can be used to create equivalent combinations of options, risk-free bonds, and stock. Suppose that there are options available on the number of points LeBron James will score in his next game. For example, a call option with an exercise price of 32 would pay off Max(0, S0 - 32), where S0 is the number of points LeBron has recorded by the end of the game.
Thus, if he scores 35, call holders receive $3 for each call. If he scores less than 32, call holders receive nothing. A put with an exercise price of 32 would pay off Max(0, 32-S0).
If LeBron scores more than 32, put holders receive nothing. If he scores 28, put holders receive $4 for each put. Obviously there is no way to actually buy a position in the underlying asset, a point.
However, put-call parity shows that the underlying asset can be recreated from a combination of puts, calls, and risk-free bonds. Show how this would be done, and give the formula for the price of a point.
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