options - Setting the r in put-call parity?

Put-call parity is given by $C + Ke^{-r(T-t)} = P + S$.

The variables $C$, $P$ and $S$ are directly observable in the market place. $T-t$ follows by the contract specification.

The variable $r$ is the risk-free interest rate -- the theoretical rate of return of an investment with zero risk.

In theory that's all very simple. But in practice there is no one objective risk-free interest rate.

So in reality, how would you go about setting $r$? Why?

Answer

If your trades are collateralized/margined, you should use the rate paid on your collateral/margin.