主讲教师

• 课程名称：期货与期权
• 宋斌 博士 副教授
–中央财经大学管理科学与工程学院投资系
–办公室：沙河校区4号楼308
 Chapter 7

Property of Stock Options-Upper and

Lower bound of Option Prices
 Methods-Arbitrage Restriction
• 1. Constructing Portfolios-Portfolio Comparison
• [Link] Arbitrage Analysis
 The Upper Bound for a Call Option Price
-European Call and American Call
Call option price can never be worth more than the
stock price.
• Otherwise, arbitrage (riskless profit) will be possible.
• How? Ct>St?
The Upper Bound for a Call Option Price
-European Call and American Call
– Suppose you see a call option selling for ct= $65, and the underlying stock
is selling for St= $60.
– The Arbitrage: sell the call, and buy the stock：c-St=5 ＞0 (at time t)
• Worst case:ST≥K? The option is exercised and you pocket K-ST+ST
=K>0(at time T).
• Best case:ST＜K? The stock sells for less than K at option expiration,
you keep 0+ST = ST>0
– Zero cash outlay today, no possibility of loss, and potential for gain.
 The Upper Bound for a Call Option Price
-European Call and American Call
• Calls
– The upper bound is C < S
Lower Bound for European Call Option Prices (No Dividends)

– If there are no dividend payouts, the lower bound is

C > max [ 0, S - Ke -rT ]

C=S
C=S-PV(K)
C

0 PV(K) K S
Lower Bound for European Call Option Prices
(No Dividends)

• Consider the two portfolios

Portfolio A: One European Call option plus cash =
Ke –rT
Portfolio B: One Share
• For PF A at expiration, T
– If the cash is invested, it will grow to K at T
– If ST > K, then the option is exercised; PF A is worth ST
• We pay for the share with the cash and have a share worth ST
– If ST < K, then the option is worthless; PF A is worth K
– Hence PF A is worth max (ST , K)
 Lower Bound for European Call Option Prices
(No Dividends)

• PF A is worth max (ST , K) at expiration

• PF B at expiration is worth ST
• At expiration, PF A has value at least as great as
PF B
• In the absence of arbitrage, this must also be true
today
• Hence c + Ke -rT  S0 or c  S0 –Ke -rT
• In addition, since the worst that can happen is that
the call will expire worthless, c  max ( S0 − Ke − rT , 0 )
Theoretical Implications of these Bounds
• Because the price of an in-the-money call must
exceed S-PV(K), in the money calls on non-
dividend paying stocks will always have some
time value before expiration.
• An American call on a non-dividend paying stock
will never be exercised before expiration. Why
exercise for S-K, when you can sell it for S-
PV(K) or more?
• The value of an American call on a non-
dividend paying stock is the same as the value
of a European call on the same stock, all else
equal.
 When will an American call be
Exercised Early? The Logic
• Exercising an option early destroys its time value, so you will only
want to exercise early if the option has no time value.
• Exercising early also destroys the downside protection provided by
a call (i.e., if ST < K), and requires spending $K earlier (thereby
losing interest that can be earned on $K).
• So, the dividend that will be paid “tomorrow” must be sufficiently
great to compensate you for these “costs” of early exercise.
Arbitrage Restrictions on Call Prices
• Assume the stock pays no dividends.

• Upper bounds are

– American: C< S0
– European: c < S0
• Lower bounds are
– American: C > max (0, S-Ke -rT )
– European: c > max (0, S-Ke -rT )
 Arbitrage Restrictions on Call Prices
• Although we can obtain the American call option’s weak lower
bound by arbitrage restriction, we still have C≥[Link] we
choose the strict lower bound
American: C > max (0, S-Ke -rT )
• From the analysis, we know the American call option (no dividend )
will never exercise early, we conclude that C=c.
 The Upper Bound for a Put
Option Price

Put option price can never be worth more than the

strike price. P < K
• Otherwise, arbitrage will be possible. How P ＞ K?
Suppose there is a put option with a strike price of K=$50
and this put is selling for P= $60.
 The Upper Bound for a Put Option Price
• Suppose there is a put option with a strike price of K=$50 and this put is selling for
P= $60.
• The Arbitrage: Sell the put, and invest the $60 in the bank. (Note you have zero
cash outlay).+ Pt(sell the put option )-Pt(riskless lending)=0
– Worse case----K≥ST? Stock price goes to zero ST →0.
• You short put option payoff is ST–K, because you were the put writer).
• But, you have from the sale of the put (plus interest)
• Total payoff is: ST -K+Pt erT >0
– Best case--- K≤ST? Stock price is at least $50 at expiration.
• The put expires with zero value (and you are off the hook).
• You keep the entire $60, plus interest.
• Total payoff is: 0+Pt erT>0
 The Upper Bound for a Put Option Price
for European Put only
• European put option price can never be worth more
than the strike price. P < Ke-rT
• Otherwise, arbitrage will be possible.
 The Upper Bound for a Put Option Price
for European Put only
• How P ＞ Ke-rT? Suppose there is a put option with a strike price of K and this
put is selling for P ＞ Ke-rT.
• The Arbitrage: Sell the put, and invest the money in the bank. (Note you
have zero cash outlay). ).+ Pt(sell the put option )-Pt(riskless lending)=0
– Worse case----K≥ST? Stock price goes to zero ST →0.
• You short put option payoff is ST–K, because you were the put writer.
• But, you have from the sale of the put (plus interest)
• Total payoff is: ST -K+Pt erT >0 (Pt erT >K)
– Best case--- K≤ST? Stock price is at least $50 at expiration.
• The put expires with zero value (and you are off the hook).
• You keep the entire $60, plus interest.
• Total payoff is: 0+Pt erT >0
 The Lower Bound for a Put Option Price
• Lower bounds are
– American: P > max (0, K-S)
– European: P > max (0, Ke-rT – S)
Lower Bound for European Put Option Prices
(No Dividends)

• Consider the two portfolios

Portfolio C: One European Put option plus
One Share
Portfolio D: Cash = Ke–rT
• For PF C at expiration T
– If ST < K, then the option is exercised; PF C is worth K
• We deliver the share and receive K
– If ST > K, then the option is worthless; PF C is worth ST
– Hence PF C is worth max (ST , K)
Lower Bound for European Put Option Prices
(No Dividends)

• PF C is worth max (ST , K) at expiration

• PF D at expiration is worth K
• At expiration, PF C has value at least as great as
PF D
• In the absence of arbitrage, this must also be
true today
• Hence p + S0  Ke-rT or p  Ke-rT – S0
• Again, since the worst that can happen is that
the put expires worthless, p  max ( Ke − S0 , 0 )
− rT
 Put Pricing Bounds: The Diagram
P
P=K
A A

P = Ke − rT
E E

P = Ke−rT − S P=K-S

E A
PV(K) K
S

Pricing Boundaries for Puts on Non-Dividend Paying Stocks

AAA shows the American put boundaries.
EEE shows the European put boundaries
 Arbitrage Restrictions on Put Prices
• Assume the stock pays no dividends.
• Upper bounds are
– American: P < K
– European: P < Ke-rT
• Lower bounds are
– American: P > max (0, K-S)
– European: P > max (0, Ke-rT – S)
• Thus, an American put cannot sell for less than its
intrinsic value, but a European put can! Thinking!
What will it mean?(from the intrinsic value and time
value)
Early Exercise of American Puts
• Once an American put is sufficiently in-
the-money, it will sell for its intrinsic value,
and it should then be exercised early.
• Exercising early will get you $K today,
rather than at expiration, and you can
immediately invest that money to earn
interest.
 Put-Call Parity
• For European options on non-dividend
paying stocks, put-call parity is:
C – P = S – PV(K)

• For European options on stocks paying

known dividends, put-call parity is:
C – P = S – PV(Divs) – PV(K)
 Put-Call Parity (No Dividends)
• Consider the two portfolios
Portfolio A: One European Call option plus cash = Ke–rT
Portfolio C: One European Put option plus One Share
• PF A at expiration, T
– If the cash is invested, it will grow to K at T
– If ST > K, then the option is exercised; PF A is worth ST
• We pay for the share with the cash and have a share worth
ST
– If ST < K, then the option is worthless; PF A is worth K
– Hence PF A is worth max (ST , K)
 Put-Call Parity (No Dividends)
• PF A is worth max (ST , K) at expiration
• PF C at expiration, T
– If ST < K, then the option is exercised; PF C is worth K
• We deliver the share and receive K
– If ST > K, then the option is worthless; PF C is worth ST
– Hence PF C is worth max (ST , K)
• At expiration, PF A has value equal to PF C
• In the absence of arbitrage, this must also be true today
• Hence c + Ke -rT = p + S0
• This is known as Put-Call Parity
 Proof of the Basic Put-Call Parity
Proposition: A Conversion
What if: C-P>S- Ke -rT?
Then: C-P-S+ Ke -rT > 0
At Expiration:
Today: ST<K ST>K
Sell call +C 0 -(ST-K)
Buy put -P +(K-ST) 0
Buy stock -S +ST +ST
Borrow + Ke -rT -K -K
>0 0 0
Therefore, if C-P>S- Ke -rT, an arbitrage is possible, because the
trader receives a cash inflow today, but does not have a cash
out-flow in the future.
 Some Theoretical Implications
of Put-Call Parity
• Rearrange, the basic put-call parity proposition to be –C=-
S+PV(K)-P. This says that buying a call is like borrowing to
buy stock; i.e., it is like buying stock on margin. But in
addition, the call owner also owns a put, providing downside
protection.
• If r > 0, an at the money call is worth more than an at the
money put with the same K and T.
• Given S, r, and T, then C-P is known, regardless of the
bullishness or bearishness that may pervade the market.
• You can replicate the payoff from any position with the other
three securities (e.g. buying a put = selling stock, lending,
and buying a call).
Put-Call Parity & Synthetic Positions
• S = C-P+PV(K) Sell stock short = write call, buy put, &
borrow
• -S = -C+P-PV(K) Buy stock = buy call, write put & lend
• -P = S-C-PV(K) Buy put = sell stock short, buy call, & lend
• P = -S+C+PV(K) Write put = buy stock, write call, & borrow
• C = S+P-PV(K) Write call = sell stock short, write put, &
lend
• -C = -S-P+PV(K) Buy call = buy stock, buy put, & borrow
• PV(K) = S-C+P Riskless borrowing = sell stock short,
buy call, & write put
• -PV(K) = -S+C-P Riskless lending = buy stock, write call,
& buy put
 Put-Call Parity

• PV(K) = S-C+P Riskless borrowing = sell stock short, buy

call, & write put
• -PV(K) = -S+C-P Riskless lending = buy stock, write
call, & buy put
• In the mid 1800s, New York financier Russell Sage began
creating synthetic loans using the principle of put-call parity
 Notation

• c : European call • C : American Call option

option price price
• p : European put • P : American Put option
option price price
• S0 : Stock price today • ST :Stock price at option
• K : Strike price maturity
• T : Life of option • D : Present value of
• : Volatility of stock dividends during option’s
price life
• r : Risk-free rate for
maturity T with cont comp
Effect of Variables on Option
Pricing (Table 9.1, page 206)
Variable c p C P
S0 + – + –
K – +? – +
T

? + +
+ + + +
r + – + –
D – + – +