Investor Glossary-volatility smileInvestor Glossary-volatility smileInvestor Glossary-volatility smileInvestor Glossary-volatility smileInsightful stock market charts - Click here
investor
Categories    # A B C D E F G H I J K L M N O P Q R S T U V W X Y Z

Volatility Smile

The HTML to link to this page
 

The options phenomena known as the volatility smile occurs when an at-the-money option (ATM) exhibits a lower implied volatility than either the in-the-money (ITM) or out-of-the-money (OTM) options. On a chart plotting implied volatility on the vertical axis and strike price on the horizontal axis, a u-shaped 'volatility smile' is formed. The volatility smile is graphed for options with the same expiration date. The volatility smile became more noticeable in equity and index options after the crash of 1987. Prior to observing the post-1987 volatility smile, it was assumed that there existed a constant and independent relationship between implied volatility and the strike price of options; the volatility smile was therefore a direct contradiction to one of the main assumptions in the Black Scholes Option Pricing Model. The presence of a volatility smile generally infers that there is more demand by option traders for in-the-money and/or out-of-the-money options rather than at-the-money options. The presence of a volatility smile then implies that the extrinsic values of the ITM and OTM options are greater than that of the ATM option. The volatility smile is generally a result of an anticipated increase in market volatility. To hedge against this expected volatility, traders are more likely to purchase and sell OTM and ITM options rather than ATM options; this excess demand is expressed by the shape of the volatility smile.



Rate this Volatility Smile definition...

Learn about investing with the Investor Glossary Term of the Day


Click here for insightful stock market charts. Where is the market headed? The answer may surprise you. Find out
with the exclusive & Barron's recommended charts of Chart of the Day.


Popular Terms: stock market close, 1031 exchange, risk management, ex-dividend date, average price per share, Zero Cost Collar, 1035 exchange, implied volatility, option premium, inflation, debt service coverage, real GDP, phantom income, class C shares, labor relations, current ratio, covered put, irrevocable trust, annual return, ex-dividend, FICO score, APR, Key Rate Duration, margin rate, FTSE, command economy, LIBOR, 144a, stock split, open position, dividends payable, balance sheet, reverse mortgage, VIX, liquidity ratio, EBITDA, 401a, required rate of return, deferred revenue, diluted share, per diem, minority interest, in escrow, retained earnings, wholly-owned subsidiary, deferred tax, cancelled check, limit order, quality assurance


Accounting | Banking | Bonds | Brokers | Economy | Futures | Mutual Funds | Options | Real Estate | Retirement | Stocks | Taxes | Technical Analysis
Home | Term of the Day | Suggest a Term | Chart of the Day | Dogs of the Dow
©2004-2016 Investor Glossary - All rights reserved - Terms of Use