Wheel Trading Strategy

The wheel trading strategy is a popular options trading strategy that involves generating income from options by buying and selling puts and covered calls.

It is a systematic approach to trading options, allowing investors to potentially generate income while acquiring or disposing of stock. However, as you’ll learn in this article, you should be careful in calling capital from financial instruments “income”.

Let’s look at the wheel trading strategy:

Table of contents:

What is the wheel trading strategy?

First, let’s look at the concept:

Understanding the concept of the wheel strategy

The wheel strategy involves a combination of two basic options trading strategies: selling put options and selling call options. It aims to generate income from the premiums collected while also potentially acquiring or selling the underlying stock.

We have previously covered this in separate articles:

How does the wheel strategy work?

When implementing the wheel strategy, an investor starts by selling a put option on a stock they wouldn’t mind owning. This is what happens:

If the option expires worthless, they keep the premium as income.

If the option is assigned, they buy 100 shares of the stock at the strike price. Because the investor issued puts, he or she doesn’t mind owning the stock at that price level. We repeat: you should only issue puts in stocks you like and at price levels you deem acceptable.

Once owning the stock, they can then sell a covered call option against it, aiming to generate additional income.

Example of implementing the wheel strategy

Let’s make a specific example to better illustrate the wheel trading strategy:

For example, suppose a trader sells a cash-secured put on a stock trading at $50 with a strike price of $45.

If the option is assigned, meaning that the price of the stock is below 45 at expiration, they purchase 100 shares of the stock at $45. They can then sell a covered call with a strike price above the purchase price, aiming to generate income. For example, issue calls with a strike price of 50 for 1 dollar per contract.

How to trade the wheel strategy?

Implementing covered call in the wheel strategy

Selling covered calls is a key component of the wheel strategy. It involves owning the underlying stock and selling call options against it, generating income from the premiums while potentially selling the stock at the strike price.

If you sell calls you “risk” being exercised if the stock goes up in price. You limit the upside, so to speak.

Using cash-secured put in the wheel strategy

The cash-secured put is another essential part of the wheel strategy, allowing the investor to potentially acquire the underlying stock at the strike price if the put option is assigned.

Selecting the ideal stock for the wheel strategy

Choosing the right stock is crucial for the wheel strategy. Investors typically look for stable stocks with sufficient liquidity and options volume to execute the strategy effectively.

Again, you should only employ this strategy in stock you don’t mind owning.

What are the key components of the option wheel strategy?

Understanding the concept of strike price in the wheel strategy

The strike price is a crucial element in the wheel strategy, determining the price at which the stock will be bought or sold if the options are exercised or assigned. It plays a significant role in executing the strategy successfully.

The strike price determines the value you pay if a put is exercised, and it determines the premium you receive when you sell calls.