Trade of the month: volatility smiles

Following our analysis of volatility skew in the January issue, we now turn our attention to when to expect a volatility smile.

Tim Mortimer, Future Value Consultants

When considering an underlying asset's behaviour there are two ways to measure volatility - looking at historical and implied volatility. Historical volatility is the standard deviation of the price series of the underlying. It only requires values for the underlying and can be computed in a spreadsheet. Implied volatility is the volatility level that the market is observing through option prices or structured products. This is harder to gauge and requires the existence of a number of liquid