The Nobel Prize went to Black & Scholes because of <i>how</i> they derived the BS equation. Ed Thorp derived BS by calculating the expected value of an option, under the standard pricing assumption (the log price undergoes a simple memoryless, constant volatility, continuous random walk). This is actually quite easy to do using no more than elementary probability and basic calculus (no stochastic calculus). I regard it as an undergraduate level homework problem, although I do have to give Thorp credit for formulating and solving the problem first. The problem is that the market has no way to enforce prices that are derived from expected value calculations. Black & Scholes showed that the price of options could be enforced by dynamic hedging. I.e., if the standard pricing assumptions hold, *and* transactions are costless, an arbitrageur can guarantee a profit by selling options that are priced above the BS price or by buying options that are below the BS price and then dynamically hedging to keep delta 0. So the BS price is in theory enforceable by the market, at least in the alternative universe where the simple stochastic pricing assumptions hold.
15+ years ago option prices were so wide market making was great. so when you hear some SPX trader was making a killing in the 80s keep in mind the bid/ask spread he was milking.
Surely, with a market down pretty big there are many credit spread traders that could be in the house of pain if one was to just be passive and hope. The good news is that there is a much better safer way to trade, you just have to find the way or be led in the right direction. The bad news is all those traditional option trades have a pretty high probability of not working or losing you a lot of money at some point in time. I only know of a couple of guys that should be known as 'famous option traders' and cracking the code but I don't think they would consider themselves as such.
perhaps Madoff should be included his split strike strategy was bunk maybe someone can explain how to identify this type of fraud. http://nakedshorts.typepad.com/files/madoff.pdf