Why Out-of-the-Money Puts Can Cost More Than Calls
Summary
The document discusses why out-of-the-money puts may be priced above calls with strikes equally distant from the underlying price, and why this does not necessarily imply an immediate expected decline. It attributes the skew partly to demand from long investors seeking downside protection and market makers’ hedging costs. Selling covered calls can add supply and lower call prices, while a temporary imbalance may also contribute.
The answers caution that parity comparisons depend on contract details. Dividends and hard-to-borrow costs can affect apparent put-call relationships, and early exercise of American options can cause deviations from parity relationships that apply at expiration. A further explanation is that prices can reflect asymmetric outcome sizes: modest gains may be more likely while large declines remain possible. The discussion is qualitative and offers no unified model or evidence beyond a cited stylized observation about put returns; the relative prices alone do not establish a simple market forecast.
Key ideas
- Demand for portfolio protection can raise put prices, while covered-call selling can weigh on call prices.
- Market makers’ hedging costs may contribute to expensive puts.
- Dividends and borrow costs can affect put-call price comparisons.
- Early exercise can alter put-call parity for American options before expiration.
- Option prices can reflect the size as well as the probability of possible moves.
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Full text
# How can put options be more expensive than call options in an efficient market? # How can put options be more expensive than call options in an efficient market? I noticed that for some securities, puts were more expensive than calls (with same expiration). For example, suppose the underlying security is trading at 50. A put with a strike of 45 is more expensive than a call with a strike of 55. A put with a strike of 40 is more expensive than a call with a strike of 60. And so on. This means that the market thinks the security has a greater chance of falling than of rising. But if this were the case, shouldn't the underlying security simply fall immediately? Shouldn't this sentiment just be priced into the underlying security until a put-call equilibrium is reached? I've read about put-call parity, but that seems to be addressing puts and calls with equal strike prices. Here, I'm talking about puts and calls with different strike prices that are equidistant from the current trading price. ## Answer by emcor (score 9, accepted) https://quant.stackexchange.com/a/18063 Its a stylized fact in academia that put options are overpriced. E.g., the monthly average return on S&P500 put options is around -40% for ATM options. The most often quoted reason for this phenomenon are hedging costs: A put is more difficult to hedge from a market maker's perspective, hence the prices artificially go up. An important paper on this issue with a good introduction can be found here: http://www.investps.com/images/Why_Are_Put_Options_So_Expensive.pdf ## Answer by Victor123 (score 7) https://quant.stackexchange.com/a/18060 The typical investor is long. To protect the portfolio, he buys puts, thus driving up the price. To generate income against his long position, he sells covered calls, thus driving down the price. This is the most basic explanation for the difference in put call prices that are equidistant from the money. Obviously other factors are there as pointed out by Thomas Baert. Last but not the least, it could be a temporary imbalance that will correct itself. ## Answer by Thomas Baert (score 4) https://quant.stackexchange.com/a/18055 if put call parity seems to be violated there could be things you are ignoring like dividends or hard to borrow fees. Hard to borrow will make puts more expensive ## Answer by Sid (score 2) https://quant.stackexchange.com/a/29893 Because American style options allow early exercise, the put-call parity will not hold unless they are held to expiration. Early exercise will result in a departure in the present values of the two portfolios. ## Answer by dm63 (score 0) https://quant.stackexchange.com/a/29898 It could be that the chances of a market falling falling are low, but the move will be large. Conversely , the market is quite likely to go up, but the move will be smaller. In other words, the market will either grind higher or fall precipitously. Thus, the market is in equilibrium , but out of the money puts cost more than out of the money calls. ## Answer by Lore (score -1) https://quant.stackexchange.com/a/29485 Puts and calls will always be exactly the same price, if not then you can take a synthetic position called a reversal, its an arbitrage opportunity and you would make free money.
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