Options Wheel Strategy

The options wheel strategy is an income producing strategy involving selling put options, potentially owning stock, and selling covered calls until the shares are called away or the position is closed. The wheel is an increasingly popular strategy for investors that want to generate income before and possibly during stock ownership. 

The wheel's primary objective is not to own stock. The strategy's goal is to consistently take in credit via selling short put options. However, selling short put options prior to owning stock reduces the position’s cost basis throughout its duration.

If assigned shares of stock, writing covered calls generates additional income until the net cost basis is below the current stock price and the position can be closed for a profit.

Options wheel strategy explained

The wheel strategy can be thought of as an active approach to passive investing that allows investors to generate consistent income. It is perfect for stock investors looking for a simple transition to options trading.

The options wheel strategy consists of two main components:

1. Selling a cash-secured put option
2. Selling a covered call if assigned stock

You can go back to step 1 to restart the “wheel” and continue the process:

Selling the short put option receives a credit for the option contract’s premium amount. Put options are typically sold out-of-the-money below the stock’s current price.

Selling cash-secured puts ensure enough capital is available to take assignment if needed. However, if you are not assigned, you can continue selling puts and collecting premium.

 If assigned the short put, you should be able and willing to buy 100 shares per contract. Once assigned, you’ll continue to own the shares and sell covered calls above the stock price, which is reduced by the premiums collected from selling puts and covered calls.

The covered calls can be sold repeatedly until the net stock cost basis is below the current stock share price. Ideally, the stock price increases slightly, but the short call expires out-of-the-money. This allows you to keep the entire premium and sell another call option for the next expiration, continuing to reduce the position’s net cost basis with each trade. The shares can then be called away or sold for a net profit.

The wheel strategy continues for as long as you want to hold the underlying stock, or the call option expires in-the-money and the shares are called away and a new short put may be sold to start the wheel over again.  

Learn more about options assignment.

How to trade the wheel strategy

It’s important to understand that if you use the wheel strategy, you should only sell put options on stocks you want to hold at a price you’re comfortable with owning the shares. 

There are two potential outcomes when trading the wheel:

1. The put option expires worthless and you keep the entire premium (this is typically the preferred outcome)
2. The put option is assigned. You hold the shares and sell covered calls until the call option is assigned or you choose to sell the stock.

If assigned shares of stock, you’ll want the stock price to increase long-term so you can realize the gains while also collecting recurring income from selling covered calls.

Sell a put option

You can sell the short put at any strike price. Many investors use the short put as an income-generating, proxy limit order and will often sell options at a price they believe is a key technical support level.

In this way, you essentially get paid to initiate a long equity position in the underlying security at a price you’d be happy to buy shares.

If the underlying security’s price is above the short put option’s strike price at expiration, the contract expires worthless, and you keep the premium received for selling the put.

You can repeat the process for as long as you wish and adjust the strike price up or down as your bias or market conditions change.

Rolling the short put can be an effective way to potentially delay assignment while collecting additional premium. The premium increases the profit if the stock’s price recovers, or lowers the net stock cost basis if assigned.  

If the stock is below the strike price at expiration, you will be assigned 100 shares per contract at the strike price. However, the position’s cost basis is reduced by the net credit of any put options sold.

For example, if you sell a put with a $100 strike price and collect $5.00 of premium, your cost basis is $95 if you’re assigned stock.

Because you will buy 100 shares per contract if assigned, your account must have available funds to purchase 100 shares.

Selling a $100 strike put option requires you to have at least $10,000 in your account.

Sell a covered call

If you’re assigned stock, you’ll initiate a covered call. The short call option also brings in credit and generates income. You can think of the covered call as the monthly rent you collect for owning the stock (and don't forget about collecting dividends along the way!).

For example, if you own stock at $100, you could sell a covered call with a $105 strike price. If you collect $5.00 for selling the call, you’ve reduced the position’s cost-basis to $95 (plus any premium received from selling put options).

If the stock price is above the call option’s strike price at expiration, the shares will automatically be sold at the strike price, and any further gains are not realized. Therefore, covered calls are typically sold at or above a pre-determined profit target you would be happy to sell the shares.

For example, if the stock is $110 at expiration, you’re required to sell shares at the call option’s $105 strike price. You’ll still keep the premium collected for selling the option, but you would forfeit any price appreciation above the strike price.

Like short puts, you can also roll a call option to potentially bring in more premium, extend the trade, and sell a higher strike price. 

Again, the premium collected from selling options continues to lower the position’s overall cost basis. The closer the short call’s strike price is to the current stock price, the more money you will collect, but there’s a higher probability the option will expire in-the-money (you can use delta to determine probabilities). 

Also, options contracts with longer expiration dates have higher premiums but, again, a higher probability the option will expire in-the-money. These are factors you will need to consider when selecting a call option.

Download a free copy of Mastering Covered Calls for in-depth research.

Wheel strategy example

Let’s assume a stock is trading at $67. You’ve determined you would be willing to own at least 100 shares at $65. You can sell a cash-secured put with a $65 strike price. The longer-dated the contract’s expiration, the more money you’ll collect because the option will have more extrinsic value.

If the stock is above the strike price at expiration, you can repeat the process for a later expiration date. If the stock trades down to $65 or lower, you may be assigned shares at $65. The premium collected on any put options reduces your cost basis. 

Once you own the stock, you could then sell a call option with a $68 strike price, further reducing your cost basis. If the stock is not called away because the stock does not trade up to the call option’s strike, the call selling is repeated the next month. If the stock is above the call option’s strike price, you must sell shares at $68, regardless of the underlying’s price.

Options wheel strategy automated

The wheel is a systematic strategy perfect for automation. Step one is choosing what tickers you want your bot to use.

Creating a custom watchlist

There are two key factors to consider when creating your wheel strategy watchlist: pick stocks you’re willing to own if you’re assigned shares and select tickers in your price range. 

It’s important to remember that if you plan to accept assignment, you must have enough capital to cover the cost of 100 shares per contract. So, if you sell a short put spread with a $67 short strike, you’ll need $6,700 of available capital if you’re assigned and choose to hold the shares.

For example, this watchlist focuses on symbols under $60 to help diversify tickers and hold multiple positions simultaneously.

Scan the market

Now that you have your tickers selected, you can create a bot and add the watchlist as bot symbols. 

You may want to filter out tickers with upcoming earnings, an RSI above 70, and avoid more than one position per symbol. You can also sort those tickers using multiple metrics.

Your bot will automatically update the watchlist every automation interval to produce a list of qualifying symbols using real-time data. Of the seven symbols in the ‘Wheel Strategy’ watchlist, four meet our criteria currently:

Next, create a simple scanner automation that loops through your symbols and opens a short put spread when your criteira are met. You can add as many decisions as you want to customize your strategy, including moving averages, technical indicators, and much more.

_{*Option Alpha supports risk-defined strategies. Short put spreads offer many benefits, including reduced maintenance requirements.}

Monitor and manage positions

There are different schools of thought for how to manage wheel positions. Some traders prefer to close or roll challenged positions to avoid assignment, while others are more than willing to take assignment and sell covered calls to increase the net credit received and lower the position’s overall cost basis. You can customize your bot’s automations to match whichever style you prefer.

This automation simply sends a notification if the stock price is below the short put strike on the day before expiration. However, you could automate closing, rolling, or taking assignment just as easily.

Selling covered calls on assigned shares

If assigned shares, you can import those shares from your broker into the bot and use a monitor automation to sell a short call spread on any long equity positions.

This 'Wheel Strategy' bot is automating the entire strategy. The bot has a short put spread, and 100 shares of long equity with a covered call.

Important considerations

Remember, the wheel option is ideal for a stock you want to own, so you have a bullish bias in the short, medium, or long-term (up to you to decide the timeframe). Selling a put option to initiate stock ownership lets you collect money while waiting for assignment. Of course, there is always the possibility that the stock won’t trigger assignment, and you’ll never own the stock. However, you’ll still keep the premium collected for selling the put.

Capital allocation requirements can be high for the wheel strategy, so make sure it fits into your overall portfolio and risk management.

While selling calls reduces the position’s cost basis, they limit its upside profit potential. Consider your long-term bias for the stock. The wheel strategy can go on for weeks, months, or years depending on the stock’s price movement. Have a defined plan for position management, and consider this checklist before initiating a position: