Volatility Smiles (FRM Part 2 2023 - Book 1 - Chapter 15)

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After completing this reading you should be able to:
- Define volatility smile and volatility skew.
- Explain the implications of put-call parity on the implied volatility of call and put options.
- Compare the shape of the volatility smile (or skew) to the shape of the implied distribution of the underlying asset price and to the pricing of options on the underlying asset.
- Describe characteristics of foreign exchange rate distributions and their
implications on option prices and implied volatility.
- Describe the volatility smile for equity options and foreign currency options
and provide possible explanations for its shape.
- Describe alternative ways of characterizing the volatility smile.
- Describe volatility term structures and volatility surfaces and how they may be used to price options.
- Explain the impact of the volatility smile on the calculation of the “Greeks.”
- Explain the impact of a single asset price jump on a volatility smile.
0:00 Introduction
1:02 Learning Objectives
1:39 Introduction
6:11 What is a Volatility Smile?
8:03 Volatility Skew
10:08 Put-Call Parity on the Implied Volatility of Call and Put Options (2/2)
13:33 Volatility Smile vs. Implied Distribution of the Underlying Asset
14:26 Implied Volatility for Currency Options (1/2)
20:33 Implied Volatility for Equity Options (2/3)
27:24 Volatility Term Structure
29:27 Volatility Surface
31:04 The Impact of the Volatility Smile on the Calculation of the Greeks
34:16 Impact of a Single Asset Price Jump on a Volatility Smile (1/2)

[@caseclosed2519]

Thanks, the first 10 minutes cleared up volatility skew/smile for CFA level 3

[@igniteyourpassion3596]

Great effort sir,
Really appriciate your valueable contribution.

[@analystprep]

You're welcome and good luck on the exam!

[@juliendark4208]

This video was excellent. Thank you so much!

[@rx5615]

Appreciate

[@giovanniberardi4134]

Thank you for the video. I have a question:
considering put-call parity, if the implied volatilities of out-of-the-money puts exceed the implied volatilities of out-of-the-money calls at similar distances from the current stock price then necessarily the implied volatility of in the money calls should exceed the implied volatilities of in the money puts at similar distances from the current stock price.
Is it right?
Thank you very much

[@analystprep]

Yes, correct according to put-call parity. However with volatility smirks (mostly) we've found empirical evidence that the put-call parity might not hold true. This is where behavioral finance comes in to explain some of those concepts. I hope this helps!

[@giovanniberardi4134]

Thank you very much!

[@AceHardy]

📙💯