Risk and the Intelligent Option Investor   • 265
For an intelligent option investor who has a long-term worst-case 
valuation that is now 20 percent higher than the market price, there is a 
wonderful opportunity to sell a put and receive a fat premium (with the 
possibility of owning the stock at an attractive discount to the likely fair 
value), sell a put and use the proceeds to buy an OTM call LEAPS, or sim-
ply buy the stock to open a position.
Indeed, this strategy is perfectly in keeping with the dictum, “Be fear-
ful when others are greedy and greedy when others are fearful. ” This strat-
egy is also perfectly reasonable but obviously rests on the ability of the 
investor to accurately estimate the actual intrinsic value of a stock. This 
brings us to the next form of risk—valuation risk.
Valuation Risk
Although valuation is not a difficult process, it is one that necessarily in-
cludes unknowable elements. In our own best- and worst-case valuation 
methodology, we have allowed for these unknowns by focusing on plausi-
ble ranges rather than precise point estimates. Of course, our best- or worst-
case estimates might be wrong. This could be due to our misunderstanding 
of the economic dynamics of the business in which we have invested or 
may even come about because of the way we originally framed the problem. 
Thinking back to how we defined our ranges, recall that we were focusing 
on one-standard-deviation probabilities—in other words, scenarios that 
might plausibly be expected to materialize two times out of three. Obvi-
ously, even if we understand the dynamics of the business very well, one 
time out of three, our valuation process will generate a fair value range that 
is, in fact, materially different from the actual intrinsic value of the stock.
In contrast to market risk, which most often is a nonmaterial and tem-
porary issue, misestimating the fair value of a stock represents a material 
risk to capital, whether our valuation range is too low or too high. If we esti-
mate a valuation range that is too low, we are likely to end up not allocating 
enough capital to the investment or using inappropriately light leverage. 
This means that we will have missed the opportunity to generate as much 
return on this investment as we may have. If we estimate a valuation range 
that is too high, we are likely to end up allocating too much capital to the