The Volatility Smile
Why post-1987 markets price OTM puts richer than the model says they should
On October 19, 1987 — Black Monday — the Dow Jones Industrial Average closed down 22.6% in a single session, the largest one-day percentage decline in its 91-year history at the time and still the largest in the 134-year history through today. The S&P 500 fell 20.
5% in the same session. Out-of-the-money puts on US equity indices, which had traded at modest premiums to the Black-Scholes theoretical price for years before the crash, suddenly proved their value: a 30-day 10% OTM put on SPX paid out almost its entire intrinsic upside in a matter of hours. The market remembered.
From October 19, 1987 to today — 38 years and counting — the implied-volatility surface for US equity index options has carried a persistent negative skew that did not exist before the crash. OTM puts trade at meaningfully higher implied volatility than at-the-money options.
That is the opening. Finishing a lesson is where it stops being interesting and starts being useful: the full lesson runs to 8 sections and ends with 6 practice questions. A free account is what opens the rest, and the other 255 lessons in the Academy with it. No card.
What this lesson covers
- 1What the smile / skew / smirk actually looks like
- 2Sticky-strike vs sticky-delta — how the smile moves with spot
- 3Vol Surface Visualizer
- 4Smile parameterizations and the smile-aware Delta
- 5Typical SPX implied-vol smile shape — 30-day expiration, normal regime
- 6October 19, 1987 — Black Monday and the birth of the persistent equity-index volatility smile
- 7Where to see this on the platform
- 8Summary