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How to Use the Wheel Options Strategy on Your Favorite Stocks

The Wheel options strategy can help turn your favorite stocks into year-long, income-generating machines, whether you own shares or not.

Tire / Wheel

At this time last year, the S&P 500 was trading for roughly 4,600, over 16% higher than where it is trading now, and many household name stocks have followed the same path as the major market index … down, down, down.

“Whether we are talking about socks or stocks, I like buying quality merchandise when it is marked down.” – Warren Buffett.

Here is the year-to-date performance of a few high-quality companies that reside within the S&P 500:

  • Netflix (NFLX) is down 51.3%
  • Amazon (AMZN) is down 48.4%
  • Intel (INTC) is down 49.4%
  • Walt Disney (DIS) is down 42.5%
  • Alphabet (GOOGL) is down 37.7%
  • FedEx (FDX) is down 33.6%
  • 3M Company (MMM) is down 31.5%
  • Microsoft (MSFT) is down 26.9%

Bear markets are painful and well, inevitable. But as history shows time and time again, they are ultimately surmountable.

“A pessimist sees the difficulty in every opportunity; an optimist sees the opportunity in every difficulty.” – Winston Churchill

At the moment, I fall into the latter part of Churchill’s quote. Opportunities are prevalent, especially for those that employ options income strategies that rely on selling. The reason I state this is because with stocks like the ones listed above, I can choose to buy stocks 10% to 15% below where they are currently trading, giving me an even deeper discount … and receive a premium (income) for doing so.

The Wheel

The wheel options strategy is an inherently bullish, mechanical, options income strategy known by various names. The covered call wheel strategy, the income cycle, and the options wheel strategy are just a few of the many names that investors use. But one thing is certain: The systematic approach remains the same.

More and more investors are choosing to use the wheel options strategy over a buy-and-hold approach because it allows you to create a steady stream of income on stocks you want to or already own.

The mechanics are simple.

  • Sell Cash-Secured Puts on a stock until you are assigned shares (100 shares for every put sold)
  • Sell Covered Calls on the assigned stock until the shares are called away
  • Repeat the Process!

Basically, find a highly liquid stock that you are bullish on and have no problem holding over the long term. Once you find a stock that you’re comfortable holding, sell out-of-the-money puts at a price where you don’t mind owning the stock.

Keep selling puts, collecting even more premium, until eventually you are assigned shares of the stock, again, at the strike price of your choice. Once you have shares of the stock in your possession begin the process of selling calls against your newly issued shares. Basically, you are just following a covered call strategy, collecting more and more premium, until the stock pushes above your call strike at expiration. Once that occurs, your stock will be called away, thereby locking in any capital gains, plus the credit you’ve collected.

Let’s go through an example on one of the stocks mentioned above to show you exactly how these options income strategies work.

Amazon (AMZN)

Wheel Options Strategy – Step One

AMZN is currently trading for 87.86.

Amazon Chart

Let’s say we are comfortable owning shares of Amazon approximately 15% below where the stock is currently trading.

As a result, we decide to sell puts at the 75 put strike.

We can sell to open the 75 puts for roughly $0.75.

But before I go any further, I want to point out an important aspect of placing a trade. Never sell at the bid price and never use a market order. Always use a limit order. All research shows that taking this approach will tack on a significant percentage to your account over the long haul. Be efficient and don’t give up easy returns; work your orders!

By selling the 75 puts for $.75 our return is 1.0%, cash-secured. Our breakeven stands at 74.25 per share and will continue to decline every time we sell premium.

If AMZN stays above our 75 put strike at expiration we begin the process of selling puts again, thereby creating more premium to use as income or to lower the cost basis of our position. So, if we bring in 1.0% every 30 days or so, and we can sell puts roughly a dozen times over the course of a year (if the stock stays above our chosen short put strike) our annual return is 12.0% on a cash-secured basis. Again, it bears repeating, we can use that capital to either produce a steady stream of income or to lower the cost basis of our position. In our case, we are selling premium to lower the cost basis of a stock that we want to own.

But what if AMZN closes below our put strike?

No biggie. We are issued or assigned shares at the price where we wanted to buy the stock. Think about it for a sec. We collect a premium to wait for a stock to hit our chosen price.

Wheel Options Strategy – Step Two

So, let’s say AMZN closes below our 75 put strike at expiration. If so, we are issued 100 shares at $75 for every put contract we’ve sold.

Once we have shares in our possession, we begin the process of selling out-of-the-money calls against our shares, which begins the covered call portion of the wheel options strategy on AMZN.

Now the question is which strike to choose. Again, ultimately it just comes down to preference. My preference is to focus on call strikes that have a delta between 0.20 to 0.40.

Let’s say we decide on selling the 95 calls against our newly issued AMZN shares for roughly $1.72 per call contract. Our probability of success on the 95 calls stands at 71.5%.

Our static return or return on capital is 1.8% over 30 days.

If AMZN stays below our 95 call strike at expiration we begin the process of selling calls again, thereby creating more premium to use as income or to lower the cost basis of our position. So, if we bring in 1.8% every 30 days, and we can sell calls roughly 12 times over the course of a year (if the stock stays below our chosen short call strike) our annual return is 21.6%. Again, it bears repeating, we can use that capital to either produce a steady stream of income or to lower the cost basis of our position.

But what if AMZN closes above our short call strike?

Again, no big deal. Our shares are called away, so of course, we keep our $172 per call contract, plus we are able to reap any capital gains from our stock.

Once our shares are called away, the wheel options strategy cycle ends, and the decision has to be made whether or not to continue using the strategy with the same stock.

The wheel options strategy is one of several wonderful options income strategies for those wanting to generate steady income, with lower risk compared to most options strategies. It also gives the investor an opportunity to lower the overall cost basis of a position.

The strategy isn’t a get-rich-quick strategy; rather, it’s a methodical, systematic approach to trading options that generate consistent returns, month after month, on stocks or ETFs that you want to hold in your portfolio over the long term.

To trade alongside me, become a Cabot Options Institute member today!

Andy Crowder is a professional options trader, researcher and Chief Analyst of Cabot Options Institute. Formerly with Oppenheimer & Co. in New York, Andy has leveraged his investment experience to develop his statistically based options trading strategy which applies probability theory to option valuations in order to execute risk-controlled trades. This proprietary strategy has been refined through two decades of research and real-world experience and has been featured in the Wall Street Journal, Seeking Alpha, and numerous other financial publications. Andy has helped thousands of option traders learn and implement his meticulous rules-driven options trading strategies through highly attended conferences, one-on-one coaching, webinars, and his work as a financial columnist. He currently resides in Bolton Valley, Vermont and when he’s not trading, teaching and writing about options, he enjoys spending time with his wife and two daughters, backcountry skiing, biking, running and enjoying all things outdoors.