The Wheel Strategy

The wheel strategy is a popular options trading strategy that involves selling cash-secured puts and, if assigned, selling covered calls. It's a strategy often used by investors seeking to generate income from their stock holdings.

Step 1: Selling a put option

The first step in the wheel strategy is to sell a put option on a stock you wouldn't mind owning at a lower price. By doing so, you receive a premium from the option buyer. If the stock price remains above the strike price by the expiration date, you keep the premium as profit, and you're free to repeat the process.

Step 2: Starting the wheel - own the stocks

If the stock price falls below the strike price, you may be assigned to buy the stock at that price. This is where the strategy gets its name, as you're said to be "wheeled" into owning the stock. However, since you chose a stock you're comfortable owning, this shouldn't be a problem.

Step 3: Running the wheel - sell covered calls

Once you own the stock, the next step is to sell covered calls. This involves selling call options against the stock you own. If the stock price doesn't reach the strike price by expiration, you keep the premium from selling the call option, adding to the income you generated from selling puts.

Step 4: Completing the wheel - stocks get called away

If the stock price rises and the call option is exercised, you'll sell your shares at the strike price, which can be a profit if the stock price has increased.

Example

XYZ is currently trading @ 100/share

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

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. By selling a covered call at $120, the investor can continue to gain premiums and downsize total cost to $94.

Goal: To sell $XYZ @ $120 after rally

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

Final Words

The wheel strategy allows investors to potentially generate income in both rising and neutral market conditions. However, it's important to carefully select stocks, manage risk, and have a clear understanding of options trading before employing this strategy.