How to Handle the Volatility With Options

The lesson that has always stuck in my mind: While volatility, both implied and historical, represents an opportunity to make money, it is vega that actually represents money. That is, a position's vega is the measure that provides the actual dollar impact of the value of an option relative to changes in volatility.

Not to take this algebraic comparison to its obvious extreme, in which "money equals money," but I think it's worth pointing out that there is incredible overlap in which an increase in volatility does translate into more money.

The value of an option is based on several components -- the underlying stock price, time remaining to expiration, the strike price and even interest rates are all easily identified. The biggest variable, and the one hardest to pin down, is implied volatility. It is essentially the "answer" to price; whether you deem it accurate is immaterial, the price is the price. One of the keys to success in trading options is to control as many variables as possible. This helps you get a better control on risk and provides a more accurate expectation for profit.

One of the best ways to mitigate or control the impact of implied volatility or your vega risk is to use spread strategies. At the most basic level is a vertical spread, which involves the simultaneous purchase and sale of an equal number of contracts on the same underlying security that have the same expiration date but different strike prices. A impact rise or decline in IV will mostly be offset by the fact that you both are long and short similar options.