Simultaneously buying a bond and a put option on a bond produces the same payoff as buying a call option on a bond.

Question

Quizplus · Accepted Answer

This statement is true. Buying a bond and a put option on a bond creates a synthetic call option on the bond. The holder of the put option has the right to sell the bond at a predetermined price (strike price) on or before the expiration date of the option. If the price of the bond increases, the holder of the put option can let the option expire and sell the bond at the higher price. If the price of the bond decreases, the holder of the put option can exercise the option and sell the bond at the strike price, which is higher than the market price, creating a profit. Essentially, this strategy simulates the payoff of a call option on the bond.

Simultaneously Buying a Bond and a Put Option on a Bond