Volatility Smile

Volatility smile is an U or smile shaped curve obtained when implied volatility is plotted against different strike prices options with the same expiration date.

According to Black-Scholes model, implied volatility would be the same for all the options that expire on the same date regardless of the strike price. Therefore, implied volatility curve should be flat when plotted against the strike price. But in real practice, implied volatility is higher as the options go in-the-money and out-of-the-money, forming a curve in the shape of a smile. This shape of the curve suggests that demand for in-the-money and out-of-the money options is more than the demand of at-the-money options.