Volatility skew describes how implied volatility varies across strike prices for options on the same underlying and expiration. A smile is a particular shape with higher IV on both sides of the middle strikes. These describe the option market's relative pricing, not a certain forecast of the underlying's direction.
Model assumption versus market prices
The basic constant-volatility Black–Scholes model assumes one underlying volatility. If market prices exactly followed that model, implied volatility would be flat across strikes. Real prices can imply a curve because the simple model does not capture every feature of returns and trading conditions.
Implied volatility is obtained by working backward from prices; it is not a direct measurement of future realized volatility. For American-style contracts, use an appropriate early-exercise model and dividend inputs. Quote quality and model choice can also affect the apparent curve.
Volatility smile
A smile has higher IV at lower and higher strikes than around the middle. The illustration shows the shape only. The precise curve depends on the underlying, expiration and market conditions; it is not a rule that short-dated equity options must display a smile.
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Downward skew or smirk
With downward skew, lower strikes have higher IV than higher strikes. This is often observed in equity index options. Downside protection demand and the pricing of large negative moves are possible contributors; a curve alone cannot identify a single cause.
| Strike | Implied volatility |
|---|---|
| $90 | 32% |
| $100 | 25% |
| $110 | 23% |
The lower strike has a higher volatility input, not necessarily a higher dollar option premium than every higher-strike option. Raw premiums also depend on intrinsic value and other contract inputs. Describing an option as relatively expensive in IV terms is different from comparing its dollar price.
Upward or forward skew
With upward skew, higher strikes have higher IV. It can occur when upside jumps are a particular concern, including in some commodity markets facing supply uncertainty. It is not a universal commodity-market pattern.
Reading the curve in practice
Use a consistent underlying, expiration, quote time and pricing model. Check bid–ask spreads and stale prices before interpreting an isolated high IV. Comparisons across different expirations also include term-structure effects.
A spread can combine legs at different IVs, and the shape can change while the trade is open. Pricing every leg at one at-the-money IV can miss that exposure. Skew is useful context for a strategy, but does not establish a guaranteed mispricing or predict whether a trade will profit.
