The volatility smile, and why equities smirk instead
Black-Scholes assumes a single volatility for every strike on a given expiry. Plot the implied volatility of real options against their strikes and you get a curve, not a line. On equity index and single-stock options that curve slopes down from left to right, which is a skew or a smirk rather than a smile.
This is the most visible place where the model everyone uses is wrong, and everyone knows it, and everyone keeps using it anyway. Worth understanding why that is not as stupid as it sounds.
The curve on one real chain
Nike, June 3, spot $74.20, the July 18 expiry at 45 days out.
| Strike | Type | Delta | Implied vol | Credit |
|---|---|---|---|---|
| $65 | put | 0.17 | 44.5% | $112 |
| $67.50 | put | 0.23 | 42.0% | $154 |
| $70 | put | 0.30 | 40.1% | $216 |
| $74 | at the money | 0.45 | 37.0% | $354 |
| $78 | call | 0.38 | 35.0% | $226 |
| $80 | call | 0.30 | 34.0% | $158 |
| $84 | call | 0.17 | 33.2% | $74 |
Read the volatility column top to bottom. It falls the whole way, 44.5 down to 33.2, monotonically. That is the skew, and it is eleven and a half volatility points wide on an ordinary large-cap on an ordinary Tuesday.
A smile would be a U: high on both wings, low in the middle. Equities do not do that. They do a downhill slide with a slight upturn at the far right that is usually too small to see. The nickname is the smirk, and it fits.
Where the shape comes from
Three explanations, all partly true, none of them complete on their own.
The distribution has a fat left tail. Black-Scholes assumes lognormal returns, which means no crashes. Stocks crash. A model that cannot represent a 20 percent gap down has to be fed a higher volatility at low strikes to produce the prices those contracts actually trade at. The skew is the market patching the model's missing tail using the only dial the model exposes.
Stocks fall faster than they rise. Volatility and price are negatively correlated in equities. Rallies grind and declines gap, and a market that knows this prices downside strikes as though the volatility will be higher by the time you get there, because historically it is.
Somebody has to hold the other side of everybody's hedge. This is the least theoretical and probably the largest. There is enormous one-directional demand for downside protection from institutions who are not price-sensitive, and comparatively little natural supply. Meanwhile upside calls have a steady seller in every covered-call program on earth. Persistent demand on one wing and persistent supply on the other bends the curve, and it stays bent.
1987 is when it appeared
Before October 1987, S&P 500 index options traded with a curve close to flat, and the mild shape they did have looked more like a symmetric smile than a slide. After the crash it never went back. The skew that every equity chain carries today is, in a real sense, the market permanently repricing an event that happened on one Monday almost forty years ago.
That is worth sitting with. The curve is not derived from anything. It is a memory, maintained by flow, and it persists because the risk it prices is real and nobody has found a reason to stop charging for it.
Where you actually see smiles
Currencies. A big move in either direction on a currency pair is a big move for somebody, and there is hedging demand on both wings, so the curve comes out roughly symmetric. Commodities often smile too, sometimes tilted the other way, because a supply shock in oil is an upside event.
Single-stock equities smirk. Equity indices smirk harder, because index puts are the instrument the entire institutional world reaches for at once.
What it means for you
Two things, immediately.
First, "Nike's IV is 37 percent" is a shorthand for the at-the-money contract, not a property of the stock. Any conversation about a stock's IV that does not name a strike and an expiry is missing two thirds of its inputs.
Second, and this is the part with money in it: as a premium seller running covered calls, cash-secured puts or the wheel, you are structurally short the cheap wing and long the expensive one. Your calls sell into the low corner of the curve and your puts sell into the high corner. That asymmetry is worth real dollars per contract, and it is the subject of the next page.
OptionsKing scores every candidate strike on a deterministic 0 to 100 scale, blends that score with the return on the capital the trade ties up, and shows you the highest-ranked handful. There is no minimum score. How it works covers what the ranking does and does not tell you.
Questions people actually ask
What is the volatility smile?
The pattern you get when you plot implied volatility against strike price for one expiry. If out-of-the-money options on both sides carry higher volatility than at-the-money ones, the curve is U-shaped and gets called a smile.
Why do equity options skew instead of smile?
Because the risks are not symmetric. Stocks gap down rather than up, the lognormal model cannot represent that, and institutional demand for downside protection is enormous while upside calls face steady supply from covered-call programs.
When did the volatility skew appear?
After the October 1987 crash. S&P 500 index options traded close to flat before it and have carried a pronounced downward slope ever since. The shape is a permanent repricing of tail risk rather than anything derived from a model.
Does the skew mean out-of-the-money puts are overpriced?
Not automatically. They are priced for a risk that is genuinely larger than a lognormal model admits. The extra premium is partly compensation you earn and partly an insurance markup you collect, and separating the two is the hard part of selling them.
Sources
Rules and thresholds above were checked against these documents on August 4, 2026. Exchange and broker rules change. Confirm anything you are about to act on with your own broker.
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Do the math on your own trade
Every price in this article is an illustrative worked example, not a quote. Read Volatility for the rest of the series, and the disclaimer before you act on any of it. Selling options carries real risk of loss, and the loss can be far larger than the premium you collected.