Options 101 Course

Take the Spot Test

The Greeks Part II

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Volatility Smiles and Skews

Volatility Smile

  • A volatility smile occurs where the near the money options have lower implied volatility than the deep ITM and deep OTM options.  When plotted on a chart, the implied volatility against strike price graph appears to be in the shape of a smile. 
  • It is not always clear why this occurs, but factors can include illiquidity leading to mispricing for deep ITM and Deep OTM options.

Volatility Skew

  • A volatility skew occurs where there is a difference in implied volatility between OTM calls and puts.  The reasons for volatility skew are not always obvious, however, factors include market sentiment and supply and demand. 


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