I have mentioned the Wheel Strategy a few times in my previous articles and together with the LEAPS strategy, it is one of the two favourite strategies in options trading. In this article, I will share with you how this strategy works.
The Wheel Strategy is very easy to understand, it is basically made up of a series of selling PUT and CALL options. When you sell a PUT option contract, you basically agree to buy 100 units of the shares of Company ABC if the market share price is below the strike price (agreed contract price) on the date of expiration. In return, you collect a premium for selling a PUT option contract.
If you are confused about how a PUT options contract works, this simple analogy may just be able to help you:
How PUT Option Works
Assuming your PUT option contract is being exercised and you have to buy 100 shares of Company ABC at the agreed (strike) price and you are a proud owner of 100 shares of Company ABC. What you can do now is to sell covered call on the 100 shares that you have. Selling a CALL option means you agree to sell 100 shares of Company ABC if the market share price rises above agreed (strike) price on expiration date. In return, you will get a premium for selling a CALL option contract.
This below analogy should help you understand CALL options better:
How Call Option Works
Assuming your CALL option contract is exercised when the market share price rises above strike price on expiration date, you now sell away 100 shares of Company and get back the money from selling 100 shares of Company ABC. With that amount, you can sell another PUT contract and collect a premium. If the PUT option contract is not exercised this time round, you collect the premium without having to buy the shares of Company ABC. Thus, you can sell another PUT contract.
In essence, the Wheel Strategy starts when you sell a PUT contract for a period, say a month.
If exercised, you sell a CALL contract with the shares you own. If not exercised on expiry date, you continue to sell another PUT contract.
If you sell a CALL option contract and it gets exercised, then you can sell a PUT contract with the sales proceeds of selling your 100 shares. If your CALL option contract is not exercised, you continue to sell another CALL contract for another period, say a month.
The Wheel Strategy is a series of selling PUT and CALL option contract, depending on when the respective contract gets exercised or not.
Let’s use Apple stock as an example.
January 2022 (Sell PUT)
On 1st Jan 2022, the market price of Apple share is $160.
You start the Wheel Strategy by selling a PUT option contract, with details as follow:
Type of Option: PUT
Strike price $165
Expiration Date: 31 Jan 2022
Premium Collected $16.50
On 31st Jan 2022, Apple stock closes at $166. You gain $1650 premium ($16.50 x 100) without requiring to buy 100 Apple Shares.
Feburary 2022 (Sell PUT)
On 1st Feb 2022, Apple share price is $166, you sell another PUT contract, with details as follow:
Type of Option: PUT
Strike price $170
Expiration Date: 28 Feb 2022
Premium Collected $10
On 28 Feb 2022, Apple stock closes at $169. Thus, your PUT options contract is exercised and you will buy 100 shares of Apple at $170. The amount you need to pay is $17,000 ($170 x 100). But you will still get to keep the premium of $1000 ($10 x 100).
March 2022 (Sell CALL)
On 1 March 22, the share price of Apple stock is $169. As you now own 100 shares of Apple, you can sell covered call for your Apple shares, with details as follow:
Type of Option: CALL
Strike price $168
Expiration Date: 30 March 2022
Premium Collected $8
On 30th March 2022, Apple stock closes at $166, which is below your strike price. You gain $800 ($8 x 100) premium without having to sell away your 100 Apple shares.
April 2022 (Sell CALL)
On 1 April 22, the share price of Apple stock is $166. As you still own 100 shares of Apple, you can sell covered CALL for your Apple shares, with details as follow:
Type of Option: CALL
Strike price $160
Expiration Date: 30 April 2022
Premium Collected $12
On 30th April 2022, Apple stock closes at $163. You gain $1200 ($12 x 100) premium from selling a CALL option contract on Apple. However, as market close price is higher than your strike price for your CALL option contract, you will have to sell away your 100 shares at $16,000 ($160 x 100).
May 2022 (Sell PUT)
On 1st May 2022, the market price of Apple share is $163. With the $16,000 that you collected from selling your 100 shares previously, you can now sell another PUT option contract and collect another month of premium
Type of Option: PUT
Strike price $160
Expiration Date: 31 May 2022
Premium Collected $14
If by month end, the option contract is exercised, you will sell CALL option in the following month. Else, you will continue to sell a PUT option contract. You take turn to spin the wheel and alternate between selling CALL and PUT option contracts.
I hope this explaination helps you understand this powerful strategy bettter. It can bring you consistent sideline income if you sell options on a stock with strong fundamentals, e.g. Apple. The price flucutation will not be drastic and you can earn good premium every month by either selling CALL or PUT options.
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What brokers or sites used by you for the options trading?
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Hi Radsin, I use Interactive Brokers. They have a paper trading account for you to practice before using your real money. Cheers 🙂
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Hi Jason, what are the criteria for u to enter a cash secured puts? Or u just enter based on implied volatility or pre-earnings ?
For both leaps and CSP , i found that u also enter OTM trades, can u explain why use OTM on CSP ? Cheers.
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Hi Tony, great question! I sell cash-secured PUT with the intention to own them for the long run, either for capital appreciation or to sell covered calls and get monthly income. I sold OTM PUT because I am bullish on the stock price and I am in a way locking in future gains. As you know, the maximum return of selling PUT is capped by the total premium. It does not matter if the share price exceed by $1 or $100 of the strike price upon expiry, the premium is still the same. I sold an OTM so if stock rise and hit SP, I get to keep the higher premium without having to buy anything. If not, I will be happy to own these stocks as they are my high conviction stocks 🙂
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Thanks for your reply Jason, appreciated it.🙂
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Hi Jason, what are some of the stocks you think I should consider for WHEEL Strategy, assuming I’ve USD20k left to deploy?
Thanks
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oh I just sold a 21.5k PUT contract on Nvidia. It is an OTM PUT contract and the return is about 1.6% for a 35 days contract. If Nvidia drops to USD215, which I think is unlikely, I think it is a very good price to own Nvidia and sell covered calls henceforth. If it does not drop to that level, the contract expires worthless and I get to sell another PUT contract next month. In fact, I do not need to wait till the expiration date. If the current rally continues, I will roll over the PUT contract and collect more premiums. You can read further about this strategy:
https://learninginvestmentwithjasoncai.com/2022/01/18/why-i-choose-to-roll-my-put-option-contract-when-share-price-rises/
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Hi Jason, in your example of SELL PUT, I realised all are ITM, is it your wanted to have higher premiums? If Sell Put what would a good percentage return? Thanks
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Hi David, thanks for your question. The examples are using ITM are just to act as an illustration as ITM stands a higher chance of getting exercised, which would mean that the options seller will now sell a covered call contract instead of another new PUT contract. Every time a contract gets exercised, it will change from selling PUT to CALL to PUT and so on. Thus, the examples are to demonstrate how one can do the wheel strategy every month and still get a good return.
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Thanks Jason, so does it mean that for Sell Put it is better to sell OTM ? Thanks
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Oh it depends, and it is always a trade off. If you sell OTM options, the premium will be lower. I usually sell ITM or ATM if I am bullish and OTM if I am bearish. The whole intent is to not get assigned so you still have your cash to keep selling cash-secured PUT contracts, while earning the premium from each contract.
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Hi Jason, in your example. The Sell PUT are all ITM. Is it you want to get high premium ? What is a good percentage of premium for WHEEL strategy? Thanks
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For wheel strategy, if you sell covered call monthly and the stock price continues to go down, for the next month are you going to do covered call at a lower strike price compared to your price of purchase?
Assume you purchase 100 shares of AMD at $150 in Dec 2021. You sell covered call at $155 (example). You happily pocket the premium as AMD is going down. January 2022, AMD is now $130. Are you going to sell covered call at $135 strike price? It does not make sense to even sell covered call at $150 at the point where you purchase cause the premium you receive is pathetic.
As AMD keeps going down to $80, how to sell covered call anymore? You would be gambling to even try to get the strike price lower say to $85 for the premium to be meaningful. Then, let’s say I gamble for strike price at $85, AMD goes up to $90. I’m forced to sell AMD shares at $85, which is way below my purchase price at $150.
Are you then going to try and “sell put” to get back the AMD shares? Yes, if you sell put, then suddenly AMD go back to $80. You are then forced to purchase AMD at $85. Which is equivalent to a loss.
This is the problem I see with wheel strategy and where I do not advocate it. Been there and experienced this horrible scenario.
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Hey Lawrence, thanks for dropping by and sharing your insight. You are absolutely right! The Wheel strategy is suitable for stock that does not fluctuate so much and stay consistently within a small range. I mentioned in another article about selling Covered CALL (CC) when the stock keeps dropping:
https://learninginvestmentwithjasoncai.com/2022/09/03/the-truth-about-options-trading-that-the-gurus-never-told-you-what-newbie-options-trader-must-know-before-getting-started/
One way to mitigate this to sell longer dated CC to farm the premium but there is only so far you can go and the shares can locked during that period.
Another way is to roll the CC to a later date if you do not want it to be exercised at a SP that you are not comfortable to sell. I have elaborated in this article:
https://learninginvestmentwithjasoncai.com/2023/03/03/how-you-can-possibly-not-lose-money-in-options-trading-how-to-trade-options-safely-for-passive-income/
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