Revelations - S3-E7
Continuity mistake: When the female watcher is being destroyed after Buffy cuts off her arm. Her sleeve is empty, which is not possible, as Buffy could not have removed the arm but not the sleeve. Also the arm on the floor is removed at the elbow, but the watcher has lost the entire arm in a previous shot.
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.