34 lines
2.1 KiB
Plaintext
34 lines
2.1 KiB
Plaintext
Option Fundamentals • 9
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developing and refining an option pricing model known as the Black-
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Scholes or Black-Scholes-Merton model, which I will hereafter abbreviate
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as the BSM.
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The BSM is a testament to human ingenuity and theoretical elegance,
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and even though new methods and refinements have been developed
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since its introduction, the underlying assumptions for new option pricing
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methods are the same as the BSM. In fact, throughout this book, when you
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see “BSM, ” think “any statistically based algorithm for determining option
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p r i c e s .”
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The point of all this background information is that options are not
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only not new-fangled financial instruments but in fact have a long and
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proud history that is deeply intertwined with the development of modern
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economies themselves. Those of you interested in a much more thorough
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coverage of the history of options would do well to read the book, Against
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the Gods: The Remarkable History of Risk, by Peter Bernstein (New Y ork:
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Wiley, 1998).
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Now that you have a good sense of what options are and how they are
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used in everyday life, let’s now turn to the single most important thing for a
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fundamental investor to appreciate about these financial instruments: their
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inherent ability to exploit directionality.
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Directionality
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The key takeaway from this section is evident from the title. In addition to
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demonstrating the directional power inherent in options, this section also
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introduces the graphic tools that I will use throughout the rest of this book
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to show the risk and reward inherent in any investment—whether it is an
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investment in a stock or an option.
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For those of you who are not well versed in options yet, this is the
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section in which I explain most of the jargon that you simply cannot escape
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when transacting in options. However, even readers who are familiar with
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options should at least skim through this explanation. Doing so will likely
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increase your appreciation for the characteristics of options that make
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them such powerful investment tools and also will introduce you to this
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novel way of visualizing them. |