How to Use the Option Wheel Strategy
A step-by-step guide navigating the Options Wheel Strategy, from potential risks and rewards, to entry and management
Strap in for an exciting ride through the options market! 🎢 Today's route? The Wheel Strategy. It's a straightforward yet potent method, both for extracting potential profit and helping you navigate through risky terrains. So let's explore what the wheel strategy is and how to master it.
Key Takeaways 💡
The Wheel Strategy involves selling put options and potentially, covered calls.
The aim is to earn income through premiums and perhaps buy stocks at a lower cost.
Understanding regular, best, and worst-case scenarios shed light on the wheel strategy's adaptability.
Choose stocks for this strategy that you're content to hold in the long run.
Beware of the potential downsides like bag holding and opportunity cost.
Wheel Strategy: The Basics 📚
Think of options trading as riding a bicycle, with the wheel strategy acting as your stabilizers. They maintain balance and control, easing you into the ride.
The journey with the wheel strategy begins by selling a put option. You're promising to buy a stock at a set price (strike price) by a certain date (expiry date). For this, you receive an upfront premium — it's like a security deposit for your willingness to buy.
Your Regular Route 🌤️
Picture this: It's April 2023, you're observing Tesla (TSLA), trading at $850. You sell a put option with a strike price of $800 expiring in May. You receive a premium of $15 per share.
Should TSLA remain over $800, your option expires worthless, and you retain the premium, a tidy profit!
Sunny Day Scenario ☀️
What if TSLA takes a dip to $800 and you get assigned? You now own TSLA at an effective price of $785 per share, considering the premium. TSLA rallies back to $850, and you sell your shares for a profit, on top of the premium collected initially. A great day in your trading journey!
Rainy Day Scenario 🌧️
Now, consider IBM for this case. You sold a put option at $140, but then IBM releases underwhelming earnings and the price plummets to $120. You're assigned, now owning the shares at $140.
In this scenario, you sell a covered call for May at $130, bagging another premium. But the storm persists; the stock hangs around $120, your call expires worthless, so you repeat the process for June. This time, the sun peeks through as the stock recovers to $135, and your shares are called away.
You've managed to soften the blow of your potential losses by pocketing premiums and riding out the storm.
But, the weather isn't always predictable. There are two key downsides to be wary of in this scenario:
Stock Price Keeps Falling (Bag Holding): If the stock price keeps descending, you'll have to sell calls at a lower price than your purchase price; otherwise, the premiums may be insignificant. This could result in you being called away at a lower price than you initially paid, realizing a loss.
Opportunity Cost: The stocks you choose for this strategy are typically those you believe will appreciate. This means you might earn more from a direct purchase if your predictions are correct than through the premiums generated by this strategy.
Your Wheel Strategy Map 🗺️
Choose a stock you're comfortable holding for the long haul.
Sell a put option on that stock, deciding a strike price and expiry date.
If the stock price remains above the strike price at expiry, great! The option expires worthless, and you pocket the premium.
If the stock price dips below the strike, you're assigned. You're now a stock owner.
Once assigned, consider selling a covered call at a strike price you're comfortable selling your shares at. Receive another premium.
Repeat the process as necessary!
With the wheel strategy, patience is your co-rider. Stay calm, collected, and remember you're in for the long haul. And there you go! You've just mastered the wheel strategy in the options market. Buckle up for your next trading journey! 🎉