Define "Volatility Smile" and Its Relation to Options Pricing during a Gap ⎊ Path

Define “Volatility Smile” and Its Relation to Options Pricing during a Gap.

Volatility smile is a pattern where options with very low and very high strike prices (far out-of-the-money) have higher implied volatility than at-the-money options. This reflects the market's expectation of extreme, low-probability events.

During a gap, the underlying asset's price has moved toward one of these "smiled" strikes, causing the IV of that option to spike further as the gap confirms the potential for extreme movement.

Define “Volatility Smile” and How It Relates to Options Pricing during Market Stress

How Does Buying a Further Out-of-the-Money Option Limit the Risk of a Sold Option?

Can Vega Be a More Significant Risk Factor than Delta for a Portfolio of Far OTM Options?

What Is the Concept of “Realized Volatility” versus “Implied Volatility” in This Context?

How Does the Concept of ‘Gamma Scalping’ Relate to the Concept of ‘Realized Volatility’?

What Is the Difference between a ‘Volatility Skew’ and a ‘Volatility Smile’?

How Does the Concept of “Volatility Smile” Change during Extreme Market Stress?

Why Is the Margin Requirement for a Short Option Typically Lower If It Is Far Out-of-the-Money?

Glossar

The Volatility Smile

Phenomenon ⎊ The volatility smile is an empirical market phenomenon where implied volatility, derived from options prices, systematically differs across various strike prices for options with the same expiration date.

Implied Volatility

Expectation ⎊ This value represents the market's consensus forecast of future asset price fluctuation, derived by reversing option pricing models using current market premiums.