What is the Wheel Strategy in Options Trading?

Wheel Strategy

Combining both Cash Secured Puts and Covered Calls is a great way for investors to buy low (using cash-secured puts) and sell high (using covered calls) and maximizing the income and capital appreciation of the stock or ETF. This is sometimes referred to as the Wheel Strategy. This generates an income while the investor waits for both the purchase and sale of a security. Using Cash Secured Puts instead of Buy Limit Orders, provides a better risk/return profile and is the preferred method to acquiring stock. Likewise, once a security is acquired, selling Covered Calls instead of Sell Limit Orders also provides a better risk/return profile when attempting to sell the stock at a higher price. 

Example

$XYZ is currently trading @ $100/share

Goal: To purchase $XYZ at $98/share with a target of $120

 Enter Buy Limit @ $98Sell Oct 15, $98 Put @$2
Risk$98/share$96/share ($98-$2 premium received)
Reward$22/share ($120-$98)$24/share ($120-$96)
ProfitableAbove $98Above $96 
TimeNo exposure until $XYZ declines to $98Rinse and repeat as income strategy until $XYZ declines to $98

In the above example, $XYZ stock can potentially be acquired for $2/share cheaper than entering a buy limit order. The ideal outlook for this strategy is that the stock has a short-term retracement before continuing a longer-term rally. Investors should have a neutral/slightly bearish short-term view while having a bullish long-term view. If the strike price is not reached and there is no assignment, the investor will keep the premium received as an income. Cash Secured Puts can be rinsed and repeated each period to generate an income stream. If the stock is acquired at $98, the investor can start selling Covered Calls which allows the investor to sell the stock after a sharp rally to maximize capital appreciation:

After acquiring the stock from selling the short put, the investor now owns 100 shares of stock $XYZ with a current market price of $98

Goal: To sell $XYZ @ $120 after rally

Sell Oct 15, 2021, $120 covered call @ $2

 Enter Sell Limit @ $120Sell Oct $120 Call @$2
Risk$96/share ($98 – $2 premium received from short put)$94/share ($98-$2-$2) (premium of covered call and premium from selling cash secured put)
Reward$24/share ($120-$96)$26/share ($120-$96-$2)
ProfitableAbove $96Above $94 ($98-$2-$2)
TimeExposure until $XYZ rises to $120Rinse and repeat as income strategy until $XYZ rises to $120

What are the Limitations

Using both strategies allows for the investor to generate income as well as taking advantage of a sharp rally in stock price. However, there are limitations to this strategy:

  • Patience is required, trades generally only execute at expiration
  • Potentially miss out on some opportunities – if the price does not retrace then the investor will not be able to purchase the stock at a discount. Additionally, the price could rally well above the strike price of the covered call which causes the investor to miss out on extra capital appreciation
  • Requires trading in 100 share increments

Best Practices and Tips

  • Acquire shares at a discount using Cash Secured Puts
  • Start selling Covered Calls immediately after acquiring shares
  • Use shorter-dated options to maximize time decay (4-7 weeks)
  • Use aggressive strikes (higher delta) for Cash Secured Puts
  • Use conservative strikes (lower delta) for Covered Calls

The Wheel strategy of using Cash Secured Puts and Covered Calls allows you to “buy low and sell high” while generating additional income from selling the put and call option. Following the best practices for the Wheel Strategy and having a consistent, methodological approach will allow you to maximize its’ effectiveness and enhance the yield and capital appreciation of your portfolio!

OptionsPlay’s Income Reports are designed to give investors the tools they need to effectively use the Wheel Strategy. Our Short Put Report allows investors to efficiently acquire stocks they wish to own while the Covered Call Report provides the optimal income-generating settings for portfolio holdings! Investors can also use the OptionsPlay platform to further analyze their income strategies:

Tony Zhang