But even in an illiquid market the P/C parity has to hold... I cannot imagine that the MM is that stoopid allowing such an arbitrage be made by others than himself...
You are getting way ahead of yourself by talking put call parity,a topic that isn't relative in this scenario. The market maker needs to hedge if he buys a deep put..In an illiquid stock,he's subject to a wide bid offer..That will be reflected in the bid for the put.. P.s. I just realized you are confusing my use of parity with put call parity. That shoud give ZD a chubby
I was referring to the posted example where spot falls to $20 from $50, the put now being $30 worth, but b/c of illiquidity it sells say $2 cheaper. I implied to say that this violates P/C parity and creates arbitrage, so shouldn't be possible in practice, IMO. I don't think one needs to go any deeper by splitting the premium into its intrinsic (aka your said "parity", ie. the amount by which an option is ITM) and extrinsic (aka "time value") components. It is said that if extrinsic value reaches 0 then usually exercise & assignment occurs. IMO one does not need this definition as my above made definition for exercise/assignment already covers this case as an implicit subset. Ie. PL calc based on premium (this is the PL calc of the buyer, sign-inverted for the seller; ie. not necessarily the real PL of the short side due to margin req etc.).
Ignoring dividends and carry,why exercise a put before expiration other than to close a position??? The option is worth more alive than dead.. This theory of exercising due to an option trading at parity doesn't hold water.. You know just about enough to be dangerous..Trade lightly,and may the force be with you
Guy is smart,willing to learn and I am pretty dam sure will pick it up pretty quickly[/QUOTe re: troll season you are using the phrase that doesn't apply. re: STFU You are becoming smaller and smaller. May the force be with you
Nice job on the quote !!! 16,620 posts and you nailed it Didn't realize you were the option teacher police..
I know you well enough to figure there must be something favorable about being assigned or you wouldn't have asked the question. lol Let's say I'm short the 50 put and the underlying is at 40. I'm either down 10 on long stock or I'm down 10 on a short put. So what's the advantage of being assigned? Since we're at parity, I guess we must be at, or close to, expiration. If I let it ride, I'm going to be assigned anyway, which means I lose 10 points minus full premium. I would also have to have a ton of money in my account to cover the long stock position. To me, that's a negative, unless I close the stock position immediately upon assignment, which I would. If I buy back my short put, I would not only lose 10 points, but the premium collected would be reduced by the amount of the buy-back price. So in that scenario, I'd say assignment would be preferable. You've thrown in an embedded call which just muddied the waters. And I don't know much of anything about embedded calls. As it pertains to risk of loss, I would say the two are equal. But, again, knowing you, that embedded call must play a role in here somewhere. With the short put, your gain is limited to the premium collected. With the long stock/embedded call, your upside could be limited to the call's strike. So the overall risk (risk of loss/risk of missing potential gains) would probably be predicated on the long stock's entry price -- which I believe would have to be the same as the short put's strike for them to be at parity -- in conjunction with the embedded call's strike. So, for instance, if you brought in $500 premium on the short put, and the embedded call's strike was 5 points above the long stocks entry price, that would seem to be about even on the overall risk. But if the call's strike was over 5 points away, it would seem the overall risk would be less with the long stock. I believe a long call and a short put, both ATM, same expiration. Not sure how that factors in to all this, but I'm sure you will tell me. Okay, I probably butchered this, but as @zdreg says, I'm just a first grader. lol
Ok,school is in session.. Pure risk reward.. Short put,vs getting assigned early and long stock.Ignore div and carry. 2 scenarios Stock trading at 43,short 10 day 50 put trading at parity.Lets say you are lucky and a 60 bid for the company comes out. Would you rather be short the put or long stock?? Flip side of the equation.Horrible News comes out.Stock goes to 10 cents.Would you rather be long stock or short put trading at parity?? Now run each scenario from the perspective of the put owner..What do they gain by exercing early?? What do they give up?? Embedded calls.. What's a synthetic long put??? More to come