A u-shaped pattern, resembling a smile, which is formed by plotting options’ implied volatilities against exercise prices. In general, implied volatilities of at-the-money options tend to be lower than those of in-the-money and out-of-the-money options. The trajectory of the pattern, however, differs across markets. For equity options, where the curve is downward sloping, volatility skew is often used to describe the pattern. For currency markets, products such as currency options or stock index options, a valley-shaped curve, where the graph turns up at both ends, is commonplace, and hence the term volatility smile is particularly indicative.
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