Chapter 2: FAQs 157
What is the Volatility Smile?
Short Answer
Volatility smile is the phrase used to describe how the
implied volatilities of options vary with their strikes. A
smilemeans that out-of-the-money puts and out-of-the-
money calls both have higher implied volatilities than
at-the-money options. Other shapes are possible as well.
A slope in the curve is called askew. So a negative skew
would be a download sloping graph of implied volatility
versus strike.
Example
0
0.05
0.1
0.15
0.2
0.25
0.3
0.35
1010 1020 1030 1040 1050 1060 1070 1080 1090 1100
Strike
Implied volatility
Figure 2-9:The volatility ‘smile’ for one-month SP500 options,
February 2004.
