Derivatives - volatility skew and volatility smile
I’m having some trouble with understanding the volatility skew and smile.
1. Volatility smile: volatility is higher for ITM and OTM, compared to ATM. Is that because of the possible gains (ITM) and losses (OTM)?
2. Skew: “to overpay for downside striked options on stocks. This meant that people were assigning relatively more volatility to the downside than to the upside, a possible indicator that downside protection was more valuable than upside speculation in the options market.”
why is that? why is there more volatility to the downside? And what is a “downside strike”?
thanks a lot!
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