TRADING

The Options “Wheel” Strategy: Is It A Good Idea?

A popular plan, but is it really so smart?

Erik Bassett

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Photo by camilo jimenez on Unsplash

“…and there is no new thing under the sun.”

I don’t believe the author of Ecclesiastes had a Robinhood account, but he unwittingly described the options “wheel” strategy anyhow.

I found online references to the wheel strategy go back to 2015-ish, but at its core are two rudimentary trades that date to the beginning of the options market. (That would be some time between antiquity and 1973, depending on how precise we are.)

But as a strategy per se, it only entered common trading parlance over the last couple years, and proliferated because of (and as a prudent alternative to) the Great Get-Rich-Quick Retail Trading Bonanza of 2021.

So, what does this mean for you as a trader or investor? Is it a bandwagon worth jumping on, or just a margin call waiting to happen?

(Spoiler: quite possibly, and generally not.)

I’m not a financial professional. This is purely opinion and entertainment, not advice. Do what’s right for you, and if in doubt about what that is, then it’s important to find someone who’s legally able to tell you.

Here’s exactly what the options wheel strategy is

The wheel strategy involves repeatedly selling put and call options against a single underlying for several weeks or months. The goal is to collect premium for reinvestment or income. Margin is not required, nor generally recommended for new traders.

The idea is not to hold shares often, nor for a long period. To that end, most wheel traders begin by writing a cash-secured put with low likelihood of assignment.

If assigned, they write a covered call (perhaps with higher likelihood of assignment) at a strike price above the cost basis of their shares.

Once assigned, they’ll write another cash-secured put against the same underlying, to keep the “wheel” rolling.

It tends to outperform in flat and slowly moving markets, but underperform in rapidly moving ones.

An example of the wheel strategy in action

Feel free to skip this section if the numbers don’t interest you.

But, for the curious:

Let’s say XYZ is trading at $80.00/share. The wheel might play out as follows.

Write cash-secured puts until assigned

To begin, write a $78.00 put (secured by $7800 cash in your brokerage account) and collect $1.50/share in premium. Remember, that put contract corresponds to 100 underlying shares, so the account credit is actually $1.50 * 100 = $150.

Let’s say XYZ is at $79.50 at expiration. That’s above $78.00, so the put expires worthless. That frees up our collateral, so we write another put. This time we use the $77.00 strike, which carries $1.00/share * 100 = $100 in premium.

That’s a total of $150 + $100 = $250 in premium, or 3.2% of our initial $7800 collateral thus far.

Not bad for a few minutes of effort over a few weeks!

Calculate cost basis after assignment

When this new put expires, XYZ is actually trading at $75.00, so we’re assigned to buy 100 shares for the strike price of $77.00 (not the spot price of $75.00).

Now, our unrealized profit/loss (P/L) is -$2.00/share * 100 = -$200 for the shares alone. But we can add the net premium of $250, so we’re actually at an unrealized P/L of -$200 + $250 = $50.

From another angle, even though we paid $77.00/share at assignment, the cost basis is $7700-$250 = $7450, or $74.50/share. That’s $0.50 below the spot price of $75.00, which again gives a P/L of $50.00 (on paper).

Write covered calls until assigned

Now, we want to unload the shares and keep collecting premium, so we write a covered call. As long as the strike price is above our cost basis of $74.50, we’ll profit on the position as a whole.

Here, we pick the $76.00 strike, which nets another $1.50/share or $150 in total premium.

XYZ is trading at $77.00 when this call expires, so we’re assigned, and the brokerage unloads our shares at $76.00/share.

That leaves us with $1.50/share in capital gains ($76 strike price less $74.50 cost basis) and another $1.50/share in premium. (We can’t count earlier premium, since that was already factored into the $74.50 cost basis.)

We’re up a grand total of $3.00/share, or $300. That’s a hair over 3.8% of our starting capital, all in the course of perhaps 4–8 weeks.

…then back to cash-secured puts

Now that we’re out of shares and back into cash, it’s time to rinse and repeat.

Back to cash-secured puts!

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What are the advantages of the wheel strategy?

With fairly stable underlying assets, the wheel strategy brings in consistent cash flow and requires almost no attention. It’s not a way to win big, but avoiding that whole gambling mentality is the point.

It’s not especially risky

The wheel strategy does not create risk beyond that of owning the underlying stock. Yes, you may end up buying shares on their way to zero (a true risk), or selling them before they blast off to the moon (an opportunity cost).

But those are inherent to shareholding in general. Using options to enter/exit share positions does not increase those risks. In fact, the premium may reduce offset downside in the event of a crash.

This does underscore the importance of choosing prudent stocks—the kind you’d already like to hold. But that, I hope, goes without saying.

It coaxes more returns out of stagnant stocks

The wheel is likely to return more than most mature firms in most years.

If you like a stock enough to buy it, but don’t expect large short-term returns, then the wheel can generate premium that feels like a synthetic dividend.

I prefer to reinvest the proceeds in long-term holdings, but many others use them to supplement their income.

It’s an easy and prudent introduction to options

Amid all the wild screenshots and scammy claims, it’s easy to forget that options are not necessarily risky, nor are they some esoteric world that requires encyclopedic knowledge and elaborate software.

Conversely, the wheel uses simple, single-leg positions with full collateral. There are few moving pieces, few decisions to make, and no need for anything more sophisticated than Robinhood.

It doesn’t require a margin account

Most other options selling strategies involve spreads and/or naked options, all of which require margin. They can work well, but without margin access, they’re simply unavailable.

The wheel uses cash and shares as collateral, so it’s fair game for everyone with an options trading account.

Whether you’re not eligible for margin or just don’t want the temptation, it’s an accessible way to start trading and learning.

It’s an efficient use of excess cash

I don’t look forward to opening emails from my bank. Not because of anything ominous, but because I’m about to learn how much they’ve lowered my APY…again.

But the forces pushing bank rates down are, kinda sorta, the forces propelling stock prices up. Not quite that simple, but you get the picture.

If you’re fortunate enough to have surplus savings, then this is a great way to put them to work—especially on the cash-secured put side.

(Of course, if equity prices are rising in general, then there may be even better opportunities. That brings up an important caveat, which we’ll come back to in a second.)

What are the disadvantages of the wheel strategy?

For all its advantages, the wheel strategy may be a poor fit for your goals or resources.

Here’s why.

It creates opportunity costs during rapid growth

The wheel is usually profitable if the underlying’s price rises dramatically. However, it’s far less profitable than simply holding the underlying.

That’s not a risk per se, but it’s a potential opportunity cost.

There’s nothing wrong with pulling in another 2% or 4% each month, fairly dependably. And if the share price doesn’t move much, then the wheel might outperform buy-and-hold by a wide margin.

But what if the underlying doubles over the course of a year? Suddenly that 2%-4% per month isn’t so impressive.

The latter is unlikely but entirely possible, even with established firms. Make sure you understand and are OK with this before using the strategy!

Taxes eat into long-term returns

There’s another reason it might make sense to simply buy and hold a company you believe in.

Unless you’re using the wheel inside an IRA, you’ll (probably) always pay the higher, short-term capital gains rate. That’s simply how options premium is taxed in most cases.

Whatever the difference between your short- and long-term capital gains rates, you’ll need to do that much better with the wheel just to break even.

(Covered call assignment on long-term holdings may be different. There’s also an exception for index options, but they’re out of the question for the wheel. You can’t actually own an index; just index ETFs, which are not the same thing for tax purposes.)

It’s easy to fixate on the wrong asset

It’s a human tendency to get attached to whatever we focus on. We crave resolution; we like consistency; we cling to sunk costs.

Whatever the cause, the wheel strategy can lead us to keep trading assets despite better returns available elsewhere.

XYZ put premiums might have been good last month, but perhaps there are better uses for the same cash today.

“Because wheel!” isn’t a good reason to stick with an underlying, so keep a handful of tickers on your watch list.

It’s capital-intensive

The wheel is best for established, stable assets…but you’ll need the capital to buy 100 shares of those assets.

And they don’t come cheap.

It’s never prudent to put your whole account into a single stock position (nor into options that could lead to a stock position). Small accounts are not conducive to this approach.

How small is too small, exactly?

The threshold is too personal to say. It depends on your resources, priorities, risk tolerance, and preferred underlyings.

Just keep in mind that any strategy, however sound, still has risks.

If you’ve got a tiny nest egg to your name, it may not be worth risking on the market at all.

The juice may not be worth the squeeze

Even though the wheel is easy and hands-off as options go, it’s still more involved that, say, dollar-cost averaging into an index fund or picking up a few dividend stocks.

Is it more profitable? Maybe. In fact, probably.

But if seizing those marginal returns takes away from more productive pursuits, then you’ll pay an overall life opportunity cost.

A few hours here and there can accomplish a lot of things. Trading is just one of them—and not necessarily the optimal one, least of all with a small account.

Returning a few percent per month can be life-changing money when the denominator is well into the tens or hundreds of thousands.

But before that point, I suspect there are better uses for your time and energy.

Bottom line: should you turn the wheel?

The wheel strategy is straightforward and low-risk. It requires very little attention beyond what you might already devote to investing. There’s no need for margin, either.

The return potential isn’t sky-high, but that’s also the point!

However, it incurs opportunity costs when the underlying stock appreciates rapidly.

It’s also too capital-intensive for small accounts to use safely. One hundred shares (or their cash equivalent) is not a trivial amount of money.

Credit spreads are more capital-efficient and work well with small accounts. They also carry different risks and require more monitoring, so they still might not be appropriate.

But all in all, the wheel strategy belongs in your toolbox as a trader. And like all tools, it can yield impressive results at the right place and time.

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