Question

What does the shape of the volatility smile reveal about put options on equity?

A. Options close-to-the-money have the lowest implied volatility

B. Options deep-in-the-money have a relatively high implied volatility

C. Options deep-out-of-the-money have a relatively high implied volatility

D. All of the above

Answer 1

The correct answer is option D. All of the above:

The shape of the volatility smile reveal the following about put options on equity:

• Options close-to-the-money have the lowest implied volatility
• Options deep-in-the-money have a relatively high implied volatility
• Options deep-out-of-the-money have a relatively high implied volatility

In other words, close to the money options have the lowest implied volatility compared to the out of the money and in the money options, which have a higher volatility.

The plot of the volatility across different strikes forms the shape of a smile.