What Is the 'Volatility Smile' and How Does It Relate to Options Pricing? ⎊ Path

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

The volatility smile is a pattern observed in the options market where at-the-money options have lower implied volatility than both in-the-money and out-of-the-money options with the same expiration date. It suggests that the Black-Scholes assumption of constant volatility across all strike prices is incorrect.

It is crucial for pricing because it shows the market's perception of risk is not uniform across strike prices.

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Do Different Strike Prices for the Same Expiration Date Have Different Implied Volatilities?

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

Explain the Concept of “Volatility Smile” or “Volatility Skew” in Options Trading

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Glossar

Volatility Smile

Shape ⎊ This refers to the graphical representation of implied volatility plotted against the option's strike price, which deviates from the flat line predicted by basic models.

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.