Question

A European call and a european put on a stock have the same strike price and time to maturity. At 10:00 am on a certain day, the price of the call is $3 and the price of the put is $4 . At 10:01 am news reaches the market that has no effect on the stock price or interest rates, but increases volatilities. As a result the price of the call changes to $3.5?

Which of the following is correct and show your calculations:

a. The put price increases to 4.5
b. The put price decreases to 3.5
c. The put price increases to 5.5
d. it is possible that there is no effect on the put price

Answer 1

The put price increases to $4.5

Option A is correct (The put price increases to 4.5)

Step-by-step explanation:

Since the price of call changes from $3 to $3.5, it means the price of call is increased by:

Increase in price of call=$3.5-$3

Increase in price of call=$0.5

From the put-call Parity, the amount of increase in put is same as the amount of increase in call.

The put price increases to $4+$0.5

The put price increases to $4.5

Option A is correct (The put price increases to 4.5)