How Does the Concept of Volatility Smile or Skew Impact Arbitrage Strategies? ▴ Learn

How Does the Concept of Volatility Smile or Skew Impact Arbitrage Strategies?

The volatility smile or skew indicates that the market does not believe volatility is constant across all strike prices. Arbitrageurs use this structure to identify relative mispricing.

For example, if an option is trading at an implied volatility that is inconsistent with the observed smile/skew pattern, it suggests a potential arbitrage opportunity by simultaneously buying the cheap option and selling the expensive one.

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