What is Volatility Smile in Options?

A “volatility smile” occurs when Implied Volatility (IV) differs across option strike prices for options with the same underlying asset and expiry. When IV is plotted against strike price, the curve can form a smile-like shape. This shape indicates relatively higher IV at both lower and higher strikes than around the middle strikes.

Such a smile-like pattern indicates that the market does not assign the same implied volatility to every strike.

Volatility Smile vs Volatility Skew: How Do They Differ?

Both volatility smile and skew are observations from the options market’s IV. A “volatility skew” occurs when implied volatility “asymmetrically” varies across strikes. For example, 

• In an equity index such as NIFTY, out-of-the-money (OTM) put options may trade with higher implied volatility than comparable out-of-the-money call options.

Let’s understand the difference between Volatility Smile and Volatility Skew in detail:

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