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Volatility smile

The U-shaped pattern of implied volatility across strikes, with both wings priced above the at-the-money level.

The volatility smile across strikesImplied volatility plotted against strike, dipping near the money and turning up at both ends, more steeply on the downside.Implied volatility32%28%24%20%8090110120Puts below the money cost moreFar calls cost more tooLowest IV near the moneyATM 100Strike price
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.

A symmetric smile says the market expects fatter tails on both sides than a normal distribution allows. It is the typical shape in currencies and many commodities, where a violent move up is roughly as plausible as one down.

Equities rarely smile; they smirk, with the put wing far above the call wing. When an equity chain does start to smile — both wings bid — it usually means the market is pricing a binary event where either outcome produces a jump, such as a takeover or a trial result.

Example: XYZ is a biotech at $50 awaiting a decision. The $40 put implies 78% and the $62.50 call implies 74%, while the $50 straddle implies 61%. Both wings are bid because the market expects XYZ to be somewhere other than $50 whatever happens.

Related: volatility-skew, volatility-surface, lognormal-assumption, earnings-play

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