Volatility smile
Principles of Finance glossary · Principles Of Finance
Definition
The pattern of implied volatilities varying across strikes; reflects departures from Black-Scholes assumptions.
Volatility smile in plain English
An "option" is a contract that lets you buy or sell something at a fixed price later, and "implied volatility" is basically how jumpy the market expects that thing's price to be — bigger expected swings make options cost more. A famous formula (Black-Scholes) assumes that jumpiness is the SAME no matter what price you set the deal at (the "strike"). In reality, when you plot the implied volatility against different strikes, the line dips in the middle and curves up on the ends, like a smile — meaning traders quietly charge extra for far-out prices, especially crash-level ones. The smile is the market's way of admitting the tidy formula's assumptions don't fully match how prices really behave.
Practice Volatility smile
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