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


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
©2004-2015 Investor Glossary - All rights reserved - Terms of Use