30 lines
1.7 KiB
Plaintext
30 lines
1.7 KiB
Plaintext
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, |