Definition
Volatility Smile
The volatility smile is the U-shaped curve formed when out-of-the-money calls and puts have higher implied volatility than at-the-money options.
If you plot implied volatility against strike price, options far from the money often show higher IV than at-the-money ones, forming a smile (or, when puts dominate, a lopsided smirk or skew). It reflects the market pricing in fatter tails — bigger surprise moves — than a simple model assumes.
Indian index options on Nifty and Bank Nifty usually show a put-heavy skew rather than a symmetric smile, because demand for downside protection lifts put IV. Reading the smile tells traders where the market sees risk and helps them choose which strikes are richly or cheaply priced.
Related terms
- VegaVega measures how much an option's premium changes when implied volatility rises or falls by 1%.
- Option ChainAn option chain is the full table of all available call and put strikes for a contract, with their prices and data.
- Options SkewOptions skew is the pattern of implied volatility differing across strike prices, usually higher for out-of-the-money puts.
- Implied VolatilityImplied volatility (IV) is the market's forward-looking estimate of how much a stock or index will swing, backed out from current option prices and expressed as an annualised percentage.
Plain-English explainer from The Dispatch Investors Encyclopedia. General information, not financial advice.