Homecoming - S3-E5
Continuity mistake: In numerous episodes, including 'Homecoming', we see vampires being killed when they weren't stabbed through the heart (the Texan girl vampire in this episode is stabbed practically in the stomach). But the show also makes an issue of the fact you have to stab a vampire directly in the heart to kill it (think the flashback in 'the Becoming, Part 2' where Buffy misses the vampire's heart, or 'Pangs' where Spike gets staked several times).
Chosen answer: Angel is saying that he is still jealous and Buffy recognizes that this is his way of saying he wishes that they could be together. That is why they both smile.