What Is the ‘Volatility Smile’ and How Does It Relate to Option Pricing?

The volatility smile is the empirical observation that options with strike prices significantly different from the current underlying price (out-of-the-money or in-the-money) have higher implied volatility than at-the-money options. It indicates that the Black-Scholes model's assumption of constant volatility is flawed, requiring market makers to use adjusted models for accurate pricing.