Cathie Woods, and her ARK Innovation ETF (ARKK) for some inexplicable reason, creates lots of mixed emotions.
As a quantitative trader, emotions are useless. They serve no purpose whatsoever. I’m focused on probabilities, implied volatility (IV), premium and various other factors.
And right now, with ARKK showing an IV over 60%, the premium is ripe for the picking.
Which leads me to a potential opportunity to use one of my favorite option strategies, known among most options traders as the Wheel Premium Strategy.
The Wheel Premium Strategy
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 ETFs you want to or already own.
The mechanics are simple.
- Sell Cash-Secured Puts on an ETF until you are assigned shares (100 shares for every put sold)
- Sell Covered Calls on the assigned ETF until the shares are called away
- Repeat the Process!
Basically, find a highly liquid ETF that you are bullish on and have no problem holding over the long term. Once you find an ETF that you’re comfortable holding, sell out-of-the-money puts at a price where you don’t mind owning the ETF.
Keep selling puts, collecting even more premium, until eventually you are assigned shares of the ETF, again, at the strike price of your choice. Once you have shares of the ETF 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 ETF pushes above your call strike at expiration. Once that occurs, your ETF will be called away, thereby locking in any capital gains, plus the credit you’ve collected.
Let’s go through an example using the ARK Innovation ETF to show you exactly how the wheel options strategy works when trading ARKK options.
ARK Innovation ETF (ARKK)
Wheel Options Strategy – Step One
ARKK is currently trading for 75.67.
Let’s say we decide to go with the 65 put strike.
We can sell to open the 65 puts for roughly $3.20.
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 65 puts for $3.20 our return is 4.92% cash-secured. Our breakeven stands at 61.80 per share.
If ARKK stays above our 65 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 4.92% every 64 days, and we can sell puts roughly six times over the course of a year (if the ETF stays above our chosen short put strike) our annual return is 29.52% 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.
But what if ARKK closes below our short put strike?
No biggie. We are issued or assigned shares at the price where we wanted to buy the ETF. Think about it for a sec. We collect a premium to wait for an ETF to hit our chosen price.
Wheel Options Strategy – Step Two
So, let’s say ARKK closes below our 65 put strike at expiration. If so, we are issued 100 shares at $65 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 ARKK.
Now the question is which strike to choose. Again, ultimately it just comes down to preference. My preference is focusing on call strikes that have a probability of success ranging from 68% to 85%.
Let’s say we decide on the selling the 86 calls against our newly issued ARKK shares for roughly $2.40 per call contract. Our probability of success on the 86 calls stands at 77.75%
Our static return or return on capital is 3.88% over 64 days.
If ARKK stays below our 86 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 3.88% every 64 days, and we can sell calls roughly six times over the course of a year (if the ETF stays below our chosen short call strike) our annual return is 23.28%. 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 ARKK closes above our short call strike?
Again, no big deal. Our shares are called away, so of course, we keep our $240 per call contract, plus we are able to reap any capital gains from our ETF. In this case, we would keep the $240 plus any additional capital gains per share (difference between our short put strike and short call strike) when our shares are called away.
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 ETF.
The wheel options strategy is a wonderful strategy 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 ETFs that you want to hold in your portfolio over the long term.
As always, if you have any questions, please do not hesitate to email me. And don’t forget to sign up for my Free Newsletter for education, research and trade ideas.