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The U-shaped pattern of implied volatility as a function of option strike price for a given maturity.
The U-shaped pattern of implied volatility as a function of option strike price for a given maturity.
The volatility smile refers to the empirical observation that out-of-the-money and in-the-money options trade at higher implied volatilities than at-the-money options. The pattern contradicts the constant-volatility assumption of Black-Scholes and reflects market expectations of fat-tailed returns and crash risk.
Most pronounced in equity index options; flatter in FX options.
Driven by demand for downside protection, jump risk, and supply-demand imbalances.
Quantified by the slope of IV across moneyness; related to kurtosis risk premium.