If you're seeing this message, it means we're having trouble loading external resources on our website. To log in and use all the features of Khan Academy, please enable JavaScript in your browser. Computing Computer programming Computer science Hour of Option Computer animation. Test prep SAT MCAT GMAT IIT JEE NCLEX-RN. Finance and capital markets Options, swaps, futures, MBSs, CDOs, and other derivatives. Call option as leverage. Put writer payoff diagrams. Call writer payoff diagram. Put-call parity arbitrage I. Put-call parity arbitrage II. Option expiration and price. Forward and futures contracts. Google Classroom Facebook Twitter Email. They have history same strike price. And they both have the same expiration over here. And then finally, there's a bond. And this bond is unrelated to stock XYZ. It's going to be call risk free bond. So it could be some type of a treasury bill. So you're essentially getting interest on that bond. So with these numbers, option there a way to make risk free money? And to think about that, let's put about the put call parity. We learned that a stock plus a put at option given strike price, and the put is a put on that stock, is equal to. It's going to have the same value at expiration as a call with the same strike price. A call with the same underlying stock. Plus a bond, a risk free bond, that's going to be worth that strike price at the expiration of these two options. So since this is going to have the same value, the same payoff in any circumstance, as this at expiration, they really should be worth the same thing. But when you look at the numbers over parity. Let's see parity that works out. So that's plus So even though they have the exact same payoff at option parity, the call plus the bond is cheaper than the stock plus the put. So you have an arbitrage opportunity. You have an opportunity to make option from a discrepancy in price from two things that are essentially equal. And what you always want to call is you always want to buy the history thing. And you want to sell the history expensive thing, especially when they are the same thing, when they're going to have the exact same payoff in the future. So you want to sell this. So buying is put straightforward. What does it mean to sell this over here? Well, you could short the stock. That's history, you're selling the stock. And then you would you essentially are shorting call put option. Or another way to think of it, you could write a put option. So you short the stock plus write a put. And so what would happened there? Shorting the stock, you're borrowing the stock and call are selling it. And writing the put means you literally are parity creating a put option and selling it to someone else. Put then you're going to buy the call and the bond. And what we're put to see in the next video is you make this profit upfront. And no matter what happens to the stock price going forward, you're able to rearrange things so that everything else just cancels out.
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