Add training workflow, datasets, and runbook
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30 • The Intelligent Option Investor
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This chapter is vital to someone aspiring to be an intelligent options
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investor. Contrary to what you might imagine, option pricing is in itself
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something that intelligent option investors seldom worry about. Much
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more important to an intelligent option investor is what option prices im-
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ply about the future price of a stock and in what circumstances option
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prices are likely to imply the wrong stock prices. In terms of our intelligent
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option investing process, we need two pieces of information:
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1. A range of future prices determined mechanically by the option
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market according to the BSM
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2. A rationally determined valuation range generated through an
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insightful valuation analysis
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This chapter gives the theoretical background necessary to derive the
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former.
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The BSM’s Main Job is to Predict Stock Prices
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By the end of this section, you should have a big-picture sense of how the
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BSM prices options that is put in terms of an everyday example. Y ou will also
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understand the assumptions underlying the BSM and how, when combined,
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these assumptions provide a prediction of the likely future value of a stock.
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Jargon introduced in this section includes the following:
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Stock price efficiency Forward price (stock)
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Lognormal distribution Efficient market hypothesis (EMH)
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Normal distribution BSM cone
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Drift
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The Big Picture
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Before we delve into the theory of option pricing, let me give you a general
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idea of the theory of option prices. Imagine that you and your spouse or
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significant other have reservations at a nice restaurant. The reservation time
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is coming up quickly, and you are still at home. The restaurant is extremely
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hard to get reservations for, and if you are not there at your reservation time,
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