DEFINITION of parity
Parity is an expression of equality. The most common use is in the forex market, where it signifies the point where two currencies have an equal value.
WHAT IT IS IN ESSENCE
This concept of equality is a financial term that has a variety of uses. But generally describes situations where two or more objects or individuals are considered equal in some way.
Underlying this concept of this equality is the idea that one or more different objects are equal or relatable in one or more ways.
That means that the exchange rate between the two currencies is exactly 1/1.
It can also find its place in options. I case when an option’s value is equal to its interior value. Also on exchanges when multiple bids are equal.
In an exchange market, it occurs when all brokers bidding for the same security have equal standing due to identical bids.
When this equality occurs, the market must determine which bidding broker will obtain the security by alternative means. Hence, the winning bid is typically awarded by random draw.
In foreign exchange (forex) markets, currencies are at parity when the exchange rate relationship is exactly one to one.
This kind of equality in terms of options. Say that this concept is the amount by which an option is in the money.
It refers to the options trading in unison with the stock.
This also means that parity and intrinsic value are closely related. Say that an option is trading at parity.
What does it mean? It means that the option’s premium consists of only its intrinsic value.
HOW TO USE
This equality is an important concept for traders. It provides them to understand as it relates to how the market is able to come to a variety of different price equilibrium. All across different assets.
Exchange rates, inputs and risk parity strategies all require prices to adjust according to an equilibrium chain that keeps everything in balance.
This concept is particularly important in arbitrage trading. As traders who are able to rapidly identify any lack of equilibrium according to price parity formulas can exploit these gaps for profit.
Market forces will often pressure prices to conform to parity price formulas, which leads to the ability to forecast price changes.
Similarly, risk parity and other strategies force portfolio managers to make certain actions. To purchase and sale to maintain the defining parity in their strategies. This represents further opportunities to make solid price forecasts.