LO 15.6: Describe alternative ways o f characterizing the volatility smile.

LO 15.6: Describe alternative ways o f characterizing the volatility smile.
The volatility smiles we have characterized thus far have examined the relationship between implied volatility and strike price. Other relationships exist which allow traders to use alternative methods to study these volatility patterns. All alternatives require a replacement of the independent variable, strike price (X).
One alternative method involves replacing the strike price with strike price divided by stock price (X / SQ). This method results in a more stable volatility smile. A second alternative
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Topic 15 Cross Reference to GARP Assigned Reading – Hull, Chapter 20
approach is to substitute the strike price with strike price divided by the forward price for the underlying asset (X / FQ). The forward price would have the same maturity date as the options being assessed. Traders sometimes view the forward price as a better gauge of at the money option prices since the forward price displays the theoretical expected stock price. A third alternative method involves replacing the strike price with the options delta. With this approach, traders are able to study volatility smiles of options other than European and American options.
V o l a t i l i t y T e r m S t r u c t u r e a n d V o l a t i l i t y S u r f a c e s

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