Smile – Pricing versus Hedging

The presence of strike-dependent smiles only affects the implied volatility of an option as regards its valuation and pricing. Due to the shortcomings of the Black-Scholes equation, implied volatility is best thought of as a price parameter for options – it is not necessarily a good description of the underlying price evolution process.
Delta and vega sensitivities that are 'thrown out' by the adjusted volatilities are not the best guides to a hedging strategy. Option expert Riccardo Rebonato points out that an adjusted, 'smiley', volatility is “the wrong number to put in the wrong formula to get the right price of plain-vanilla options”.