44 lines
1.9 KiB
Plaintext
44 lines
1.9 KiB
Plaintext
Finding Mispriced Options • 161
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On the upside, we can see that our likely case valuation is $43 per share,
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whereas the BSM’s most likely value is a bit less than $35—a difference of
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more than 20 percent. This is the area on the graph labeled “ A. ” The BSM
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prices options based on the likelihood of the stock hitting a certain price
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level. The BSM considers the $43 price level to be relatively unlikely, whereas
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I consider it relatively likely. As such, I believe that options that allow me to
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gain exposure to the upside potential of Oracle—call options—are underval-
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ued. In keeping with the age-old rule of investing to buy low, I will want to
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gain exposure to Oracle’s upside by buying low-priced call options.
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On the downside, I notice that there is a fairly large discrepancy
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between my worst-case valuation ($30) and the lower leg of the BSM cone
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(approximately $24)—this is the region of the graph labeled “B, ” and the
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separation between the two values is again (just by chance) about 20 percent.
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The BSM is pricing options granting exposure to the downside—put
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options—struck at $24 as if they were fairly likely to occur; something that
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is fairly likely to occur will be priced expensively by the BSM. My analysis,
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on the other hand, makes me think that the BSM’s valuation outcome is
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very unlikely. The discrepancy implies that I believe the put options to be
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overvalued—the BSM sees a $24 valuation as likely, with expensive options,
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whereas I see it as unlikely, with nearly valueless options. In this case, we
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should consider the other half of the age-old investing maxim and sell high.
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In a graphic representation, this strategy might look like this:
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6/21/201612/24/20156/27/201512/29/20147/2/20141/3/20147/7/20131/8/20137/12/2012
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Date
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Oracle (ORCL)
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Price per Share
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60
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Best Case
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Likely Case
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Worst Case
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40
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50
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30
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10
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20
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Downside
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Upside
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-
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$52
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$43
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$30
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GREEN
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RED |