What’s the Wheel Options Strategy? (And How to Generate Income)

Last updated on September 20, 2023

Alright, folks, let’s dive into the fascinating world of the wheel options strategy. You’ve probably heard about it, and maybe you’re even itching to give it a spin.

Well, hang tight, because we’re about to unravel this income-generating strategy that’s making waves among investors.

So, what’s the deal with the wheel options strategy?

Wheel Options Strategy: Key Takeaways
The Options Wheel Strategy generates income by selling put options, potentially owning stock, and selling covered calls.
Its primary objective is consistent income via short put options, not stock ownership.
Investors willing to own the stock at a certain price sell cash-secured puts.
If assigned shares, covered calls generate additional income and reduce the cost basis.
The strategy suits those with a bullish bias on a stock.
Capital allocation should align with portfolio and risk management.
Selling calls limits upside profit potential but lowers the overall cost basis.
The strategy can span weeks, months, or years, depending on the stock’s movement.
Having a defined plan for position management is crucial.
Careful consideration of the stock’s potential movements and your risk tolerance is essential.

It’s a clever way to generate income by selling options and, potentially, owning some stock along the way. Picture it as a financial journey where you’re not just in it for the stock ownership; you’re all about raking in those sweet credits through short put options.

Here’s how it rolls:

➤ What is the wheel options strategy?

The Options Wheel is like the MVP of active yet straightforward investing. It’s perfect for stock enthusiasts dipping their toes into the world of options. This strategy has two core moves:

Step 1: Sell Put Options (cash secured)

First up, we’ve got the cash-secured put option. Selling one of these bad boys brings home the bacon, or rather, the premium amount of the option contract. Usually, these put options are sold below the current stock price, kind of like grabbing a bargain in the stock market.

But wait, there’s more. When you sell these cash-secured puts, you’ve got to make sure you’ve got enough capital in your corner to buy 100 shares per contract if the need arises. It’s all about being prepared.

However, if Lady Luck isn’t in the mood to assign you those shares, you can keep selling puts and collecting those premiums.

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Step 2: Sell Covered Calls (if assigned)

Now, let’s talk about what happens if you do end up with the stock. You’re in luck because it’s time to sell some covered calls. This is where the income party really gets started.

You see, by selling these calls above the stock price (which you’ve cleverly lowered through the premiums from those puts and covered calls), you’re essentially making money while holding your stocks.

Now, here’s the game plan: keep selling those covered calls until the cost basis of your stock is below the current share price. It’s like trying to catch a slight updraft in stock prices while those short calls expire out-of-the-money.

That means you pocket the entire premium and prepare for the next round by selling another call option. With each trade, you’re steadily chipping away at the net cost basis of your position. The end game? Your shares can be called away for a sweet net profit.

wheel options strategy

And guess what? You can keep this wheel turning as long as you like, or until those calls are in-the-money and the shares are whisked away. But no worries, you can always start a fresh cycle with a new short put.

How to trade the wheel options strategy

Alright, buckle up because we’re about to take a spin through the ins and outs of trading the wheel strategy. Remember, this strategy is all about control and comfort, so let’s dive in.

First things first, when you’re working the wheel, you’ve got to be picky. Only sell put options on stocks that you’re absolutely fine with holding. You should be thinking, “Would I be okay owning these shares at this price?” If the answer is a confident nod, you’re on the right track.

Now, let’s talk outcomes. When you’re in the wheel game, there are two potential scenarios:

Put Option Expires Worthless

This is the gold star outcome. If the put option expires without getting assigned, you get to keep the entire premium. And let’s be honest, that’s what you’re aiming for most of the time.

Put Option Gets Assigned

If your put option gets assigned, don’t fret. It’s all part of the wheel’s dance. You’ll end up with the stock in your portfolio, and that’s when the real fun begins.

You’ll start selling those covered calls, bringing in income like a monthly rent check. Plus, don’t forget about those dividends—you’re the landlord now!

Now, if you do find yourself as the proud owner of the stock, here’s the goal: you want that stock price to trend upward in the long run. That way, you can enjoy the gains and keep cashing in with those covered calls.

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How to sell a put option

When it’s time to sell a put option, you’ve got flexibility. Pick any strike price that suits your fancy. Many investors treat the short put as an income generator, almost like setting a limit order at a technical support level they believe in.

Here’s the sweet part: you’re basically getting paid to initiate a long equity position at a price you’re content with. And if the stock price ends up higher than your put option’s strike price when it expires, you’re in luck. The contract goes “poof” and you pocket the premium.

You can keep this cycle going for as long as you please. Adjust the strike price as your bias or market conditions shift. If you ever need to delay the assignment, consider rolling the short put.

This helps collect extra premium, giving your profit a boost if the stock stages a comeback, or lowering your net stock cost basis if you do get assigned.

Now, if the stock takes a dive below your put option’s strike price at expiration, guess what? You’re the proud owner of 100 shares per contract at that strike price. But don’t sweat it, because your position’s cost basis drops by the net credit you received from selling those put options.

For instance, if you sold a put with a $100 strike price and scored a sweet $5.00 premium, your cost basis sits pretty at $95 if you’re assigned the stock. Not too shabby, right?

How to sell a covered call

Once you’re in the driver’s seat with those shares, it’s time to rev up your engine by selling a covered call. Think of it as the monthly rent you’re charging for owning the stock (and don’t forget about those dividend payments, they’re like icing on the cake).

Picture this: You own stock valued at $100, and you decide to sell a covered call with a $105 strike price. If you cash in $5.00 for selling that call, your position’s cost basis drops to $95 (don’t forget to add any premium received from selling those put options).

Now, if the stock’s price is above the call option’s strike price when it expires, the shares will be automatically sold at that strike price. Any further price gains? Sorry, not this time. That’s why covered calls are typically sold at or above a predetermined profit target you’re comfortable with.

For instance, if the stock hits $110 at expiration, you’re required to sell your shares at the call option’s $105 strike price. You still keep the premium from the option, but any extra profit above the strike price slips through your fingers.

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But hey, there’s a twist—just like with short puts, you can roll a call option to potentially squeeze out more premium, extend the trade, and aim for a higher strike price.

However, remember that the closer the short call’s strike price is to the current stock price, the more premium you’ll collect. Just keep in mind that there’s a higher chance the option will expire in-the-money (you can always use delta to figure out the odds).

And while we’re at it, here’s a pro tip: options with longer expiration dates usually come with juicier premiums. But, yes, you guessed it, there’s a higher chance they’ll expire in-the-money. It’s all about balancing risk and reward.

Wheel Options Strategy example

Alright, let’s roll up our sleeves and dive into a practical example of the wheel strategy.

Imagine this: a stock is currently trading at $67, and you’ve set your sights on owning at least 100 shares at $65.

Here’s how you can make the wheel strategy work for you:

Step 1: Selling a Cash-Secured Put

You decide to sell a cash-secured put with a $65 strike price. The key to maximizing your returns here is to opt for a longer-dated contract expiration. The longer the expiration, the juicier the premium, thanks to that lovely extrinsic value.

Now, if the stock happens to stay above that $65 strike price when the expiration date rolls around, you can rinse and repeat. Simply set up another put option for a later expiration date. But what if the stock takes a dip and goes down to $65 or even lower? Well, you might just find yourself assigned 100 shares at $65, which isn’t all that bad.

Plus, the premium you collected from those put options acts like a sweet discount, reducing your overall cost basis.

Step 2: Enter the Covered Call Game

Now that you’re the proud owner of those shares, it’s time to flex those covered call muscles. Picture this: you can sell a call option with a $68 strike price. This nifty move will further trim down your cost basis.

But remember, if the stock doesn’t rally up to that call option’s strike price, you get to keep playing the game and sell another call next month.

However, if the stock does manage to soar above the call option’s strike price, you’re on the hook to sell those shares at $68, regardless of where the stock price stands. It’s a win-win situation either way.

Wheel Options Strategy ExampleNet CreditCost Basis
Stock trading at $67
Sell-to-open: June $65 Put for +$2.00$2.00
At expiration stock = $68. Put expires worthless$2.00
Sell-to-open: July $65 Put for +$1.00$3.00
At expiration stock = $64$3.00
Assigned 100 shares at $65 (short put strike price)$3.00
Cost basis = $62 (strike price – total credit received)$3.00$62
Sell-to-open: August $68 Call for +$1.00$4.00$61
At expiration stock = $66. Call expires worthless$4.00$61
Sell-to-open: September $68 Call for +$2.00$6.00$59
At expiration stock = $70$6.00$59
Call option exercised, sell shares at $68$6.00$59
Total profit = $68 (short call) – $65 (short put assignment) = +$3.00
+$6.00 option premium received = $9.00
Cost basis = $59; sell stock at $68 = $900 profit

Wheel Options Strategy (Key Things to Remember)

As you embark on your wheel strategy journey, remember that it’s tailor-made for stocks you genuinely want to own. So, you need to have a bullish bias, whether it’s in the short, medium, or long-term (you decide how far you want to look ahead).

Selling a put option to kick off stock ownership allows you to pocket some cash while you wait for that sweet assignment. And even if the stock doesn’t quite make the cut, you still walk away with the premium from selling the put.

But here’s a heads up: the wheel strategy can be a bit of a capital hog, so be sure it aligns with your overall portfolio and risk management strategy.

Now, let’s talk upside and downside. While selling calls is an excellent way to lower your position’s cost basis, it does put a cap on your profit potential.

So, make sure you’ve got a clear long-term outlook for the stock. The wheel can keep on turning for weeks, months, or even years, depending on how the stock moves.

Before diving in, have a rock-solid plan for managing your position. Consider this checklist as your roadmap to success. Ready to give it a go?

Wheel Options Strategy: Key Questions to Consider
1. Do you really want to own the stock?
2. What is your time horizon?
3. Are you bullish on the stock?
3. What is your ideal put option selling price?
4. Do you have enough money to buy 100 shares?
5. Will you be patient if you’re not assigned immediately?
6. Are you happy selling the stock if it gets called away?
Pavlos Written by:

Hey — It’s Pavlos. Just another human sharing my thoughts on all things money. Nothing more, nothing less.