270  •   The Intelligent Option Investor
Short Investment Time Horizons
When the scholars developing the BSM were researching financial 
markets for the purpose of developing their model, the longest-tenor 
options had expirations only a few months distant. Most market partic-
ipants tended to trade in the front-month  contracts (i.e., the contracts 
that will expire first), as is still mainly the case. Indeed, thinking back 
to our preceding discussion about price randomness, over short time 
horizons, it is very difficult to prove that asset price movements are not 
random.
As such, the BSM is almost custom designed to handle short time 
horizons well.
Perhaps not unsurprisingly, agents
1 are happy to encourage clients to 
trade options with short tenors because
1. It gives them more opportunities per year to receive fees and com-
missions from their clients. 
2. They are mainly interested in reliably generating income on the 
basis of the bid-ask spread, and bid-ask spreads differ on the basis 
of liquidity, not time to expiration. 
3. Shorter time frames offer fewer chances for unexpected price 
movements in the underlying that the market makers have a hard 
time hedging.
In essence, a good option market maker is akin to a used car sales-
man. He knows that he can buy at a low price and sell at a high one, so his 
main interest is in getting as many customers to transact as possible. With 
this perspective, the market maker is happy to use the BSM, which seems 
to give reasonable enough option valuations over the time period about 
which he most cares.
In the case of short-term option valuations, the theory describes 
reality accurately enough, and structural forces (such as wide bid-ask 
spreads) make it hard to exploit mispricings if and when they occur. 
To see an example of this, let’s take a look at what the BSM assumes is 
a reasonable range of prices for a company with assumed 20 percent 
volatility over a period of 30 days.