Question

You notice a european call and a european put on a stock have the same strike price and time to maturity on an options exchange. At 10:00am on a certain day, the price of the call is $3 and the price of the put is $4. At 10:01am news reaches the market that has no effect on the stock price or interest rates, but decreases the volatility of the stock. As a result, the price of the call changes to $2.50.
1. If put-call parity holds, which of the following is correct?a. The put price increases to $4.50b. The put price decreases to $3.50c. The put price increases to $5.50d. Cannot be determined

Answer 1

Answer: b. The put price decreases to $3.50

Explanation:

Put - Call Parity refers to the relationship that a certain European Put has with a European Call of the same underlying asset, strike price, and expiration date.

If Put - Call Clarity holds then the options and the calls should move together when Volatility changes all else being equal.

In the above scenario, the price of the call DROPPED by $0.5 to $2.50.

This means that the Put Price must DROP AS WELL by $0.5 to $3.50 to maintain the Parity.