Volatility Smiles

When markets are leaning bullish or bearish, the extent of the shift in sentiment to one side may be predictive of price action that follows in the days ahead. Option traders try to detect the strength of bearish and bullish sentiment by looking at volatility smiles. The volatility smile is simply a graphic of the volatility surface. It reflects an imbalance in the implied volatilities of an option at the same strike price. Either the implied volatility of puts at the same strike price is greater than the implied volatility of calls at that strike price or vice-versa. If the market crowd was neutral in terms of direction there would be no skew. It would be a perfect smile! But that hardly ever occurs. The more experienced binary option traders may want to use volatility smiles to see which way the market is leaning. It provides more evidence, not necessarily where the market will go, but where the opinion pool is clustering.