The implied volatility of the strike nearest the forward price; the reference point from which the rest of the surface is quoted.
Traders describe a surface as an at-the-money level plus a skew plus a term structure. The at-the-money number is the anchor because it carries the most vega, has the tightest bid-ask-spread, and is the least distorted by supply and demand for wings.
It is also the figure most headline volatility measures approximate. When someone says XYZ volatility is 25%, they almost always mean the 30-day at-the-money level, not an average of the whole chain.
Example: XYZ at $50.20 with the 30-day forward at $50.30. The $50 straddle implies 25.1% and the $52.50 strike implies 23.4%. The at-the-money figure is 25.1%, and the difference between them is the skew, not a change in the general level of volatility.
Original diagrams for the ideas on this page. Illustrative, not real market data.
Long straddle: payoff at expiry. A 100 call and a 100 put bought together for 8 make a V. A quiet market that ends near 100 costs the whole 8; the position only turns positive once the price finishes below 92 or above 108, whichever way it goes.The volatility smile. Options on the same stock and the same expiry are not priced off one volatility. Strikes near the money carry the lowest implied volatility, and it rises towards both ends — usually faster on the downside, which tilts the smile into a skew.
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