The Intelligent Option Investor: Applying Value Investing to the World of Options

The Intelligent Option Investor: Applying Value Investing to the World of Options

by Erik Kobayashi-Solomon


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If you're a value investor who wants to get your money into the lucrative options market, forget about day trading, chart patterns, and market timing. This systematic book lays out a path to long-term wealth by taking positions on companies with real intrinsic value—the kind Ben Graham and Warren Buffett would invest in.

Leave the complex algorithms and "Greeks" for the floor traders. Erik Kobayashi-Solomon, former investment banker, hedge fund risk manager, and valuation consultant to the World Bank, gives you the knowledge and sophistication to understand what options pricing reveals about the market's estimation of future stock prices. He then demonstrates how to find tremendous opportunity for low-risk, high-profit investments in the difference between the market's mechanized price ranges and ones made by you, a thoughtful human being armed with the insight this book offers.

Everything you need to make options a powerful contributor to your portfolio is inside, including:

  • A thorough explanation of what options are and what their prices can tell you about the market's expectations for the future price of a stock
  • A proven way to envision the risk/reward trade-off for stocks and options and a straightforward method to use the flexibility and directionality of options to tilt the risk/return balance in your favor
  • A robust and intuitive framework for assessing the value of a company
  • Strategies to avoid the most common behavioral pitfalls
  • Tips for using the information on an option-pricing screen
  • Thorough coverage of important option investment strategies, including "covered calls," "protective puts," and "collars"

Regardless of your experience level with options, this versatile guide makes you a better investor. Beginners get a turnkey solution to growing wealth in options, experienced investors gain savvy guidance for fine-tuning their practices, and professional investors learn how to effectively incorporate options into a portfolio.

Understanding valuation in this perceptive light lets you earn the consistent profi ts of The Intelligent
Option Investor

The Intelligent Option Investor is the hands-on guide to using a cuttingedge valuation framework in the fast-paced options market to boost growth, protect gains, and generate income.

It explains how to use your insightful human mind to recognize when mechanized options pricing undervalues a stock. Once you see an opportunity, you'll have all the tools you need to execute a fact-based decision about how and when to invest in the company.

Have your money make the most for you with the potent blend of timehonored value investing strategies and hot options vehicles in The Intelligent Option Investor.


"The Intelligent Option Investor reflects Erik's keen understanding of how companies create value for their owners, which is essential to successful option investing. In addition to showcasing Erik's expertise in developing option investment strategies based on fundamental security analysis and a long-term time horizon, this book delivers the information in a way that’s accessible to individual investors, offering them the resources to use options to help them meet their financial goals." — JOE MANSUETO, founder, chairman, and CEO, Morningstar, Inc.

"Erik knows—and lays out here—that to use options successfully, you need to understand the underlying stock and its valuation first. This is one of few books on options that teaches this fruitful, combined approach. And that's why it works." — JEFF FISCHER, advisor, Motley Fool Options

Product Details

ISBN-13: 9780071833653
Publisher: McGraw-Hill Professional Publishing
Publication date: 09/25/2014
Pages: 336
Product dimensions: 9.10(w) x 5.90(h) x 1.30(d)

About the Author

Erik Kobayashi-Solomon is the founder and principal of IOI, LLC and the Director of Research for YCharts, Inc. Previously, he served as Morningstar's Market Strategist and as co-editor of the Morningstar OptionInvestor newsletter. In addition to publishing well-received sector and stock-specific reports for YCharts' individual and institutional clients, Erik has been sought out by a wide range of institutional investors—from the World Bank to value-oriented hedge funds—for his expertise in corporate valuation, option investing strategies, and risk control issues.

Table of Contents

Acknowledgments xi

Introduction xiii

Part I Options for the Intelligent Investor 1

Chapter 1 Option Fundamentals 3

Characteristics and History 4

Directionality 9

Flexibility 20

Chapter 2 The Black-Scholes-Merton Model 29

The BSM's Main Job is to Predict Stock Prices 30

The BSM is Lousy at Its Main Job 39

Chapter 3 The Intelligent Investor's Guide to Option Pricing 49

How Option Prices are Determined 50

Time Value versus Intrinsic Value 56

How Changing Market Conditions Affect Option Prices 59

Part II A Sound Intellectual Framework for Assessing Value 75

Chapter 4 The Golden Rule of Valuation 77

The Value of an Asset 78

Cash Flows Generated on Behalf of Owners 80

The Company's Economic Life 82

Time Value of Money: Summing Up Cash Flows Over Time 87

Chapter 5 The Four Drivers of Value 91

Bird's Eye View of the Valuation Process 91

A Detailed Look at the Drivers of Value 97

Chapter 6 Understanding and Overcoming Investing Pitfalls 113

Behavioral Biases 114

Structural Impediments 131

Part III Intelligent Option Investing 141

Chapter 7 Finding Mispriced Options 143

Making Sense of Option Quotes 144

Delta: The Most Useful of the Greeks 151

Comparing an Intelligent Valuation Range with a BSM Range 155

Chapter 8 Understanding and Managing Leverage 163

Investment Leverage 164

Simple Ways of Measuring Option Investment leverage 169

Understanding Leverages Effects on a Portfolio 174

Managing Leverage 183

Chapter 9 Gaining Exposure 187

Long Call 189

Long Put 201

Strangle 205

Straddle 208

Chapter 10 Accepting Exposure 211

Short Put 212

Short Call (Call Spread) 220

Short Straddle/Short Strangle 230

Chapter 11 Mixing Exposure 233

Long Diagonal 235

Short Diagonal 238

Covered Call 240

Protective Puts 248

Collar 258

Chapter 12 Risk and the Intelligent Option Investor 263

Market Risk 263

Valuation Risk 265

Intelligent Option Investing 267

Appendix A Choose Your Battles Wisely 269

Where the BSM Works Best 269

Where the BSM Works Worst 273

Appendix B The Many Faces of Leverage 282

Operational Leverage 282

Financial Leverage 285

Appendix C Put-Call Parity 287

Dividend Arbitrage and Put-Call Parity 288

Notes 295

Index 305

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