The Wheel Options Strategy: A Step-by-Step Guide to Generating Income

The Wheel Options Strategy: A Step-by-Step Guide to Generating Income

The Wheel strategy is a popular options trading approach that allows investors to generate income while accumulating shares of quality stocks at a discount. It’s an excellent strategy for both beginners and experienced traders who want to combine options income with long-term stock ownership. The wheel strategy is ideal for investors who can afford to buy 200 shares of stock. Here’s how it works.

Phase 0: Selling Cash-Secured Puts

The first step in the Wheel strategy is selling cash-secured put options on a stock you’re willing to own. A put option gives the buyer the right to sell shares to you at a predetermined strike price before expiration. By selling a put, you receive a premium (income) and agree to buy the stock if its price falls below the strike price.

• Choose a stock you’d be happy to own.
  
• Ensure you have enough cash to purchase 200 shares if assigned.

• Action: Collect premium by:
  • Sell a put option at a strike price where you’d be comfortable buying shares.
• If the stock stays above the strike price, the option expires worthless, and you keep the premium. You can then sell another put and repeat the process.

• If the stock drops below the strike price, you will be assigned 100 shares at the agreed price.

Phase 100: Selling a Cash Secured Put & a Selling Covered Call

Once you own 100 shares, the next step is to sell a covered call option against your position. A call option gives the buyer the right to purchase your shares at a specific strike price before expiration.

• Action: Collect premium by:
  • Sell a put option below the current underlying price.
  • Sell a call option above the current underlying price.
• If the stock stay above the put and below the call at expiration, you keep your 100 shares and Repeat Phase 100.
• If the stock drops below the put strike, you will buy 100 more shares and move to Phase 200.
• If the stock rises above the call strike price, your 100 shares get called away at a profit and the trade is complete. 

Phase 200: Selling 2x Covered Calls

Once you own 200 shares, the next step is to sell a covered call options against your position.

• Action: Collect additional premium by:
  
  • Sell 2x call option above the current underlying price.
• If the stock stays below the call at expiration, you keep your 200 shares and Repeat Phase 200.
  
• If the stock rises above the call strike price, your 200 shares get called away at a profit and the trade is complete. 

Repeating the Process

The Wheel strategy is a cycle. Whether you keep the shares and sell more calls or your shares are called away and you return to selling puts, the goal is to consistently generate income while managing risk.

Benefits of the Wheel Strategy

• Steady Income: You collect premiums from selling options at every step.
• Lower Cost Basis: By selling puts, you acquire shares at a discount compared to market prices.
• Reduced Risk: You only trade stocks you’re willing to own, reducing downside risk by collecting premium.
• Compounding Potential: Reinvesting option premiums and gains can accelerate portfolio growth.

Key Considerations

• Wheel is a BULLISH strategy and makes money if stock trades sideways or up.
• Choose liquid stocks with tight bid-ask spreads to minimize slippage.
• Be mindful of implied volatility; higher IV means higher premiums but also greater risk.
• Manage risk by selecting stocks with strong fundamentals to avoid holding declining assets.

One of the key factors in trading the wheel is tracking the trades which is why I created the Wheel Options Tracker

Did you know that you can sell a synthetic short put using long stock and covered calls? Check out the Never-Ending Wheel strategy.

Disclaimer: I am not a financial planner and am not offering investment advice. View expressed are my opinion only and should not be taken as any form of financial advice. There are financial risks involved in taking on any monetary transaction.