We have developed a mathematical model of skin coloration in cephalopods, a class of aquatic animals. Cephalopods utilize neurological and physiological control of various skin components to achieve active camouflage and communication. Specific physical processes of this coloration are identified and modeled, utilizing available biological materials data, to simulate active spectral changes in pigment-bearing organs and structural iridescent cells. Excellent agreement with in vitro measurements of squid skin is obtained. A detailed understanding of the physical principles underlying cephalopod coloration is expected to yield insights into the behavioral ecology of these animals.