It’s inevitable that, on any given day, Wall Street is mispricing a publicly traded security’s option premium. Specifically, the standard Black-Scholes model effectively states the following for debit-based transactions: assuming the stock moves randomly with constant volatility and no memory, the fair price of a call option is the expected discounted payoff of owning the stock above the strike price at expiration.
As such, the model provides a clean template as a reference point but without much contextual backing. Before I get flooded with emails from angry pedants ready to defend Black-Scholes’ honor, let’s really consider the trifecta of why I made the above statement. We know that:
