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