I Only Have Eyes For You - S2-E19
Factual error: In the episode 'I Only Have Eyes For You', during the flashbacks to 1955 James and Grace dance, and James later shoots himself, to the song 'I Only Have Eyes For You', which wasn't released until 1959. (00:18:20 - 00:26:50)
Factual error: When Angelus is torturing Giles in this episode he is seen with Giles' glasses, and he cleans them by breathing on the glass and wiping with a cloth. Vampires don't have breath, as Angel tells Xander in 'Prophecy Girl' from season one - even if he can force some air out of his body, it wouldn't be warm, moist air, which is needed for condensation to clean glasses with.
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.