The forward price of the underlying derived from the options market via put-call parity; the level around which the volatility surface is really centred.
The at-the-money strike is not the spot price — it is the strike where the call and put trade at the same price, which is the implied forward. With rates and dividends in the mix, the forward can sit meaningfully above or below spot, and the whole volatility-surface is quoted relative to it.
Getting this wrong distorts everything downstream. If you centre a skew analysis on spot rather than the forward, a name with a large dividend or an expensive borrow will appear to have a skew it does not have, and your delta-as-probability readings will be systematically off.
Example: XYZ spot $50.00, one-year rate 4%, expected dividends $1.20. The one-year implied forward is roughly $50.80. The at-the-money volatility belongs to the $50.80 strike, not the $50 strike, even though the screen centres on $50.
Original diagrams for the ideas on this page. Illustrative, not real market data.
Buying a call: payoff at expiry. A 105-strike call bought for 3 loses that whole 3 if the price finishes at or below 105, breaks even at 108, then gains a dollar for every dollar higher. The loss is capped at the premium; the upside is not capped.The volatility smile. Options on the same stock and the same expiry are not priced off one volatility. Strikes near the money carry the lowest implied volatility, and it rises towards both ends — usually faster on the downside, which tilts the smile into a skew.
Educational only, not advice. Spotted an error? Post in Site Feedback.