The Wheel Strategy

As easy as 1 -2 – 3

You must have enough cash to buy 200 shares of the underlying stock.

1 – Sell 1 Cash Secured Put near the money.

I like to sell a put with strike price 1 strike below Underlying Stock Price. Sometimes I may choose a different strike price. It just depends on the expected move of the underlying and how much risk I want to put on. I thought about making the play based on specific deltas but decided to keep my trading a bit more flexible.

In the example below. Ishares Mexico was selling at $41 dollars on November 20, 2020. I chose a strike price one month out near the money for $40. This was around 17% in the money trade / 83% out of the money trade. That’s pretty good odds in that it may not get assigned. The bid / ask for this option was .90/.96. I sold the put for a 0.95 cent premium credit x 100 shares = $95 income.

At Expiration – if the underlying stock price goes up, you keep the premium and then start Step 1 again.

Note – I will sometimes close this option (buy it back) early if I’ve collected 95% or better on the option and roll the option to the next month at another strike price near the money. This is just a fancy way of saying that I closed (bought back) the December Option early and sold the next month’s option.

At Expiration – If the Underlying stock price goes below your option strike price, you get to keep the original premium, but you will be assigned and take ownership of 100 shares. At this point, move on to the next step.

2 – Sell a Straddle

Ok, now that you have ownership of 100 shares of stock you are going to sell a Straddle 1 month out and at the money.

This simply means that you will sell 1 Covered Call option and sell 1 Cash Covered Put option at the money.

Most broker software can simplify this. Below is an example of my Power E-trade Software that helps put the Straddle together. As you can see, I am selling 1 Covered Call and 1 Cash covered put for $41. This is at the stock’s underlying price (at the money) give or take a few cents.

In this example I will receive a premium credit of $241.

At Expiration – if the underlying stock price goes up, you keep the premium, your stock is assigned (called away), your put expires worthless, and then you go back to Step 1 again.

At Expiration – If the Underlying stock price goes below your Call option and Put option strike price you get to keep the original call and put premiums, but you will be assigned on the Put and take ownership of another 100 shares. You now own 200 shares of Ishares Mexico.

At this point, move on to the next step.

3 – Sell 2 Covered Calls

You will now sell 2 calls on the 200 shares of Ishares Mexico that you own near the money.

I choose the call option, near the money 1 strike above the underlying price. So, if Ishares Mexico underlying price is $41 then choose the $42 options strike price. The bid / ask for this option was .55/.60. I sold the put for a 0.57 cent premium credit x 200 shares = $114 income.

At Expiration – if the underlying stock price goes up through your call strike price, your calls are assigned (stock called away). You get to keep the premium then go back to Step 1.

At Expiration – If the Underlying stock price goes below your Call option strike price, you get to keep the original premium, and then start over with step 2.

Notes

You can also do this strategy by selling Weekly options. This will potentially make you more, but you have to make the time to adjust weekly instead of monthly.

A bonus to this strategy is that you will collect dividends, if the stock provides it, on shares you hold.

You can lose money on this strategy if you are holding shares and the stock drops and never recovers. I personally like to use ETF stocks that have been stable within a range for the past 10 years. This is more like swing trading.

Only trade on stocks you would not mind owning and holding in your retirement account.

There are many variations on this strategy. I like this strategy because it utilizes a straddle to collect two premiums on a play and staying within the confines of the wheel strategy.

Do not be married to the stock. One trap you can fall into is continuing to hold the shares as the stock falls and collect greater premiums at the expense of losing money on the underlying stock price.

Consider Using Stop Losses in case Black Swan events happen. You can also place a farther out long option to protect against such catastrophes. This is why I tend to use stocks that historically trade in a tight range and pay decent premiums. In the worst-case scenario, you are stuck holding stock for a while until the market recuperates. There are many ways to trade options and play this strategy. The whole point is to keep putting money in your cash pile and move on.

Keep an eye on your cost bases. If you are losing more than your original cost, just breaking even, or continuously getting assigned – you may want to adjust your technique and maybe move more towards more delta-neutral trades.