278  •   The Intelligent Option Investor
Given what you know about the BSM, does this seem like the kind of 
situation conducive to accurate option pricing? This example certainly does 
not sound like the pricing scenario of a short-term agricultural commodity, 
after all. If this hypothetical drug company’s stock price was sitting at $50 per 
share, what is the value of the upper range the option market might be 
pricing in? Let’s assume that this stock is trading with a forward volatility of 
100 percent per year (on the day I am writing this, there are only four stocks 
with options trading at a price that implies a forward volatility of greater than 
100 percent). What price range does this 100 percent per year volatility imply, 
and can we design an option structure that would allow us to profit from a big 
move in either direction? Here is a diagram of this situation:
5/18/2012
-
500
50
100
150
200
250
300
350
400
450
5/20/2013 249 499
Date/Day Count
Advanced Biotechnology Co. (ABC)
Stock Price
749 999
GREEN
GREEN
Indeed, even boosting volatility assumptions to a very high level, 
it seems that we can still afford to gain exposure to both the upside and 
downside of this stock at a very reasonable price. Y ou can see from the pre-
ceding diagram that both regions of exposure on the put side and the call 
side are outside the BSM cone, meaning that they will be relatively cheap. 
The options market is trying to boost the price of the options enough so 
that the calls and puts are fairly priced, but for various reasons (including 
behavioral biases), most of the time it fails miserably.