Volatility Smile: Why Implied Volatility Can Rise on Both Option Wings

What is a Volatility Smile?

A volatility smile is a pattern in which options with strikes far below and far above the current underlying price have higher Implied Volatility than options near the money for the same expiration.

Plotted against strike, the curve can resemble a smile:

1Implied volatility
2high     \       /
3          \     /
4low        \___/
5          low  ATM  high strike

A simplified option chain might show:

1Strike      Implied volatility
280          31%
390          25%
4100 ATM     21%
5110         24%
6120         30%

The central idea is that the market does not assign one common volatility input to every strike.

A smile conflicts with the simplest constant-volatility model

The standard Black-Scholes-Merton Model uses a single volatility input for otherwise comparable European options.

If the model assumptions held exactly, market prices inverted through the model would produce the same implied volatility across strikes.

A persistent smile shows that real option prices do not fit that flat-volatility picture.

The market effectively requires a higher BSM volatility input to explain wing-option prices than to explain near-the-money prices.

That can reflect richer return distributions, changing volatility, jump risk, supply and demand, liquidity, and the compensation option sellers require for tail exposure.

Smile and skew describe different shapes

A Volatility Skew is usually asymmetric. In equity markets, downside puts often carry substantially higher implied volatility than upside calls.

A smile is more symmetric in concept: both wings are elevated relative to the center.

Compare:

1Smile:
2left wing high -> ATM lower -> right wing high
3
4Downside skew:
5left wing high -> progressively lower toward right wing

Real curves can contain both features. A market may have a smile that is tilted, producing an asymmetric "smirk."

The labels are shorthand for geometry. The actual strike-by-strike data matter more than whether a curve is given one name or another.

Why wing options can command higher implied volatility

Options far from the money are especially exposed to large underlying moves.

A simple lognormal constant-volatility model can understate how frequently real markets experience large jumps or heavy-tail events.

If market participants assign more value to those tail states than the simple model does, wing options can trade at higher prices. When those prices are translated back through BSM, the result appears as higher implied volatility.

That does not mean traders consciously choose one distribution and calculate the smile from it. The curve emerges from actual bids, offers, hedging needs, balance-sheet constraints, and beliefs across the market.

Currency markets are a classic smile example

Foreign-exchange options often display smile-like structures in which both large positive and negative currency moves receive more option premium than a simple normal-return framework would imply.

The market may also show asymmetry through risk reversals, which compare call-wing and put-wing implied volatilities.

A surface can therefore contain both:

• smile curvature, describing how much the wings rise relative to the center; and
• skew or risk reversal, describing how one wing differs from the other.

These are separate dimensions of the strike structure.

Equity markets often look more like a smirk

Broad equity-index options frequently show a pronounced downside skew rather than a symmetric smile.

Out-of-the-money puts can be much richer in implied-volatility terms than equally distant upside calls because investors demand crash protection and downside jumps can coincide with rising volatility.

Practitioners may still refer loosely to the entire strike curve as the "smile."

That terminology can create confusion.

When analyzing the curve, specify what you actually mean: the full strike-dependent IV function, its downside slope, its wing curvature, or a particular risk-reversal or butterfly measure.

Butterfly measures can summarize smile curvature

Options markets often compress the curve into a few relative-volatility statistics.

One common idea is a butterfly measure that compares wing implied volatilities with at-the-money implied volatility.

A simplified conceptual form is:

1Smile curvature
2≈ average wing IV - ATM IV

Exact market conventions vary by asset class and delta definition.

A larger positive value suggests the wings are richer relative to the center.

Like a risk reversal, this statistic is a summary. It does not reproduce the whole curve.

The coordinate system changes the picture

A smile can be plotted against:

• strike;
• strike divided by spot;
• forward moneyness;
• log-moneyness;
• delta; or
• another normalized measure.

The visual shape can look different depending on the axis.

For example, a fixed strike does not represent the same economic moneyness after the underlying moves sharply. Delta-based coordinates can help compare options with similar modeled sensitivity across dates, but delta itself depends on the pricing model and volatility input.

There is no perfectly model-free chart of implied-volatility geometry.

A smile can move even when spot does not

Suppose the underlying price remains at $100 and at-the-money IV remains near 20%.

If demand for tail protection increases, the 80-strike put and 120-strike call can rise in price relative to the center.

Their implied volatilities might increase from 25% to 30% while ATM IV stays near 20%.

The smile has become more curved even though the headline ATM volatility number barely changed.

A strategy exposed to wing options can therefore experience a meaningful repricing that a single IV statistic misses.

A smile is expiration-specific

One maturity may show a strong smile while another is relatively flat.

Short-dated options can be dominated by a known event. Longer-dated options blend many possible future regimes.

For example, an earnings announcement, court ruling, election, regulatory decision, or central-bank event may create unusual strike pricing in a nearby expiration.

A three-month expiration can price the same event differently because the event occupies a smaller portion of the remaining life.

The collection of smile shapes across maturities forms an Implied Volatility Surface.

Smile dynamics matter after the underlying moves

A static smile is only one snapshot.

If the underlying price changes, the volatility curve can move too.

Possible behaviors include:

• the smile staying fixed by strike;
• the smile moving with spot;
• the smile staying more stable in delta coordinates;
• downside skew steepening as spot falls; or
• the entire volatility level rising or falling.

Different modeling approaches make different assumptions about these dynamics.

A strategy's actual P&L can depend on how the surface moves, not merely on its starting shape.

This is especially relevant to positions with meaningful Option Vega and Option Gamma.

Smile does not mean both tails are equally likely

A symmetric-looking implied-volatility smile should not be read as proof that large up and down moves have equal real-world probabilities.

Option prices are risk-neutral prices, not direct frequency counts of future outcomes.

They embed risk premia, supply and demand, hedging costs, and market constraints.

Even if call and put wings have similar implied volatilities, the actual return distribution can be asymmetric.

Likewise, a more expensive wing can reflect a higher price of risk rather than only a higher probability of the event.

Put-call parity still matters

Calls and puts with matching strike and expiration remain linked by Put-Call Parity under appropriate European no-arbitrage assumptions.

That means a coherent smile cannot assign arbitrary unrelated prices to calls and puts.

For the same strike and maturity, call and put prices must remain consistent with the underlying, financing, dividends, and carry.

Apparent call-versus-put IV differences can arise from quote conventions, American exercise, or input assumptions even when the underlying prices satisfy parity reasonably well.

Surface construction often benefits from checking price-space arbitrage relationships rather than trusting raw IV marks blindly.

Liquidity can create fake-looking curvature

Far-wing options often trade less actively than near-the-money contracts.

A stale last price or wide bid-ask spread can produce an extreme implied volatility that looks like genuine smile curvature.

Reliable analysis should consider:

• bid and ask rather than only last trade;
• quote age;
• minimum tick size;
• open interest and trading activity;
• whether the option is deep in or out of the money; and
• whether the calculated IV is numerically stable.

The farther an option price approaches its no-arbitrage bounds, the more sensitive an implied-volatility calculation can become to small quote changes.

The smile is often used as a model diagnostic

A flat-volatility model is useful as a reference because deviations become visible.

If every strike requires a different implied volatility, the pattern tells the analyst where the simple model is systematically missing market prices.

The smile can therefore guide richer models such as local-volatility, stochastic-volatility, or jump-diffusion frameworks.

Those models attempt to explain or reproduce the surface with additional dynamics.

More sophisticated does not mean assumption-free. A model that fits today's smile perfectly can still describe tomorrow's surface dynamics poorly.

Strategies can be exposed to smile curvature

A butterfly spread, condor, ratio spread, or other multi-strike position is sensitive to relative pricing across strikes.

If all legs are modeled with one volatility, the estimated value can differ materially from a market that prices a curved smile.

This is why option strategy analysis should not automatically plug the same IV into every leg.

The relative implied volatilities matter just as the individual option Option Delta, theta, and gamma values matter.

A strategy can be neutral to a broad move in ATM volatility yet exposed to changes in smile curvature.

What a volatility smile cannot tell you

A volatility smile does not directly forecast future realized volatility, tail probabilities, or market direction. It does not prove wing options are overpriced merely because their IV is higher than ATM IV.

It is also not a permanent fingerprint. Smile shape changes across maturities and through time.

Its core informational value is that market option prices cannot generally be summarized by one constant implied-volatility input across strikes.

Grizzly Bulls' Models can provide broader systematic-research context, while Indicators can frame market regimes. Neither route publishes a canonical live smile curve or option-chain surface.

Sources and further reading

• CFA Institute: Options Strategies, 2026 curriculum
• CFA Institute: Valuation of Contingent Claims, 2026 curriculum
• Options Industry Council: Volatility Skew and Options: An Overview

Explore more topics in the Financial Research Encyclopedia.