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Part II
A sound intellectuAl 
frAmework for 
Assessing vAlue
After reading Part I, you should have a very good theoretical grasp on 
how options work and how option prices predict the future prices of stocks. 
This takes us partway to the goal of becoming intelligent option investors. 
The next step is to understand how to make intelligent, rational es-
timates of the value of a company. It makes no sense at all for a person to 
invest his or her own capital buying or selling an option if he or she does not 
have a good understanding of the value of the underlying stock.
The problem for most investors—both professional and individual—
is that they are confused about how to estimate the value of a stock. As such, 
even those who understand how the Black-Scholes-Merton model (BSM) 
predicts future stock prices are not confident that they can do any better. 
There is a good reason for the confusion among both professional and 
private investors: they are not taught to pay attention to the right things. 
Individual investors, by and large, do not receive training in the basic tools 
of valuation analysis—discounted cash flows and how economic transac-
tions are represented in a set of financial statements. Professional investors 
are exquisitely trained in these tools but too often spend time spinning 
their wheels considering immaterial details simply because that is what 
they have been trained to do and because their compensation usually relies 
on short- rather than long-term performance. They have all the tools in the 
world but are taught to apply them to answering the wrong questions.