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The Intelligent Option Investor: Applying Value Investing to the World of Options by Erik Kobayashi-Solomon

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Chapter 2

THE BLACK-SCHOLES-MERTON MODEL

As you can tell from Chapter 1, options are in fact simple financial instruments that allow investors to split the financial exposure to a stock into upside and downside ranges and then allow investors to gain or accept that exposure with great flexibility. Although the concept of an option is simple, trying to figure out what a fair price is for an option’s range of exposure is trickier. The first part of this chapter details how options are priced according to the Black-Scholes-Merton model (BSM)—the mathematical option pricing model mentioned in Chapter 1—and how these prices predict future stock prices.

Many facets of the BSM have been identified by the market at large as incorrect, and you will see ...

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