Wheel Strategy: Why sell calls or puts when you can sell both for perpetual option premium?

Definition of Wheel Strategy

n. An option strategy that involves selling put and call options in an alternating fashion as assignment occurs.

The moment you are old enough to take the wheel, responsibility lies with you. (J. K. Rowling)

TL;DR

1. Requires option permission to sell cash secured puts and covered calls.
2. Minimum cash needed is enough to buy 100 shares of the underlying stock.
3. Can be adapted to work well in any market condition by adjusting which options are sold.
4. Is a way to trade options that does not require good timing.

Example of a Wheel Strategy

1. Let's say Ford is trading at $12, start by selling the 11.50 strike put option expiring in 3 weeks
2. Then Ford drops to $11.20 on expiration date and you are assigned 100 shares at a price of $11.50
3. Then sell the 12 strike call option expiring in 3 weeks
4. Then ford's price trades at $11.70 on expiration, the call option expires worthless
5. Then sell another call option and continue until the shares are called away.
6. Once the shares are called away, continue the strategy by selling another put option

What’s the Worst That Can Happen?

The stock price trades sideways

In this case, the wheel continues wherever it is. If the position is fully scaled, continue selling call options. If the position is still scaling and you own some shares, sell both put and call options.

The stock price goes up a lot

In this case, it is likely that any covered shares will be called away. Continue the strategy by selling put options.

The stock price goes down a lot

In this case, it is likely that you will be assigned shares of stock on any outstanding put contracts. Continue the strategy by selling call options on the assigned shares.

Managing the Trade

The wheel strategy can be completely “sell it and forget it”. In this manner, the options are sold and the strategy continues in whatever direction the market feels. The strategy could also be more complex and option positions can be closed according to different rules such as percent profit, amount of extrinsic value remaining, or days remaining, or current Theta, or a host of other conditions.

Investors that don't wish to be assigned will seek to close options and open new ones as the contracts approach their last 10 days (have 10 DTE). This is because this is usually the time when there is less extrinsic value in the contracts and the probability of assignment goes up (especially if there just happens to be some sudden move in the stock that goes in favor of the option holder).

If the strike price of the option is close to the stock price as it nears expiration, the investor may be frustrated by how much premium remains and may not be able to close it for much profit. Thus if rolling the option out to the next month, the investor gives up a disproportionate amount of premium.

Adapting to Market Conditions

The investor adjusts the strategy by adjusting the options that are sold. We call an option that is closer to at the money (ATM) or in the money (ITM) to be more aggressive, and an option that is further away from the option price out of the money (OOTM) to be more defensive. With those terms in mind, one can adjust the strategy to fit market conditions as such:

**Advancing Market: ** Sell more aggressive puts and more defensive calls

**Declining Market: ** Sell more aggressive calls and more defensive puts

**Sideways Market: ** Sell more aggressive calls and puts

Tiblio AI Take

This is one of the best option strategies because the investor can sell options in a way that maximizes option income (premium) without needing to time the market. This has the effect of reducing maximum draw downs in the portfolio, essentially, the option income reduces overall portfolio volatility while potentially increasing overall gains at the same time. You can see these effects on our benchmark portfolio.

The strategy, while it seems easy at first, can be difficult and laborious for the investor to keep up with as it requires regular selling of new options contracts and continuously calculating different key metrics, namely position size and adjusted cost basis. Not to mention dealing with human emotions that will prevent one from operating the strategy out of fear of market timing or fear of missing out (FOMO). The investor will be tested when the time comes to sell call options after the stock has fallen.

This is one area where our bot really shines. You can simply set the configuration telling the bot how you want it to operate the Wheel Strategy and the bot will take care of all of the heavy lifting to get it done.

As mentioned above, one may want to adjust the strategy to fit market conditions. This can be done with your automated trading bot as well by changing the configuration settings for the target Delta and target Days to Expiration (DTE) settings.