Interpretation of put-call parity violation and tax effect

Abstract

This paper proposes the relaxed boundaries for put-call parity under US tax treatment, and analyzes the violations of put-call parity before and after American Taxpayer Relief Act of 2012 (ATRA) in US stock options market. Put-call parity must hold to avoid market arbitrage, but violations of the relationship are commonly observed in option markets. While there are several factors that affect put-call parity, this paper concentrates on the tax effects. The paper constructs relaxed put-call parity boundaries considering US tax treatment for European and American options. After ATRA, we observe an incremental increase of put-call parity violations. However, under tax-considered put-call parity boundaries, we show that the increment of put-call parity violation is not statistically significant, thus the increase of put-call parity violation came from change of tax treatment. Furthermore, this paper shows that other simple relaxed parity boundaries considering transaction cost cannot interpret the increment of parity violations after ATRA.