Options Trading Wheel Strategy: Pros & Cons | Best Stock Strategy
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Wheel Strategy

Wheel Strategy Options Trading Strategy (Pros and Cons)

David Jaffee of BestStockStrategy.com breaks down the wheel strategy and whether or not it is right for you. 

What is the wheel strategy?

The wheel strategy is when you sell an out-of-the money put. If that put option ends up expiring in-the-money, you take assignment of that stock and then sell out-of-the-money call options. 

If that call option becomes in the money, the long stock / long shares will get called away from you, closing out the position. 

To summarize:

  1. Sell an out of the money put

  2. If that position expires in-the-money, then you take assignment

  3. Sell an out-of-the-money call 

  4. Continuously sell out of the money call until the position is called away from you

What are the pros of the wheel strategy?

The first pro of the wheel strategy is that it is relatively low risk. 

It is low risk because you are selling an out of the money put option, so the stock would have to fall below its current market price. 

Then, you are further reducing your risk by selling out of the money call options to reduce your basis and collect more premium. 

The second advantage of the wheel strategy is that it provides you with a win rate that is over 50%.

Having a relatively high win rate is very important if your goal is to become a successful and profitable trader. 

Another advantage is that you can actually participate in the upside of the stock if you’re assigned the shares. 

This works out extremely well if a stock is oversold and then begins going up again. By being long the shares, you are able to participate in the upside. 

The final major advantage of the wheel strategy is one that isn’t often mentioned. 

When you are long stock you’re not going to be adversely affected by the volatility expansion that is inherent in options during a large sell off. 

As a result, if you sell a relatively far out of the money put option and it gets assigned to you, you’re not going to have to deal with the buying power reduction that is inherent during a large volatility expansion event because equities do not have a volatility component. 

What are the disadvantages of the wheel strategy?

The first disadvantage is that the wheel strategy is not capital efficient because you’re going to be long stock.  

The second disadvantage is that the wheel strategy has a lower win rate than selling out of the money put options and rolling and managing positions (as opposed to taking ownership of the stock when running the wheel). 

Your win rate when you run the wheel option trading strategy is going to be over 50%, but when you sell an out of the money put or call option, your win rate can easily be over 95%.

Maybe your win rate on the wheel strategy will be 60% to 65%. However, your win rate when you sell an out of the money put option can be over 95%. 

The third disadvantage is that your upside participation for owning the stock is capped by the strike price selection for the call option that you’re selling. 

As a result, you’re not able to fully realize the upside potential of the stock because your profits will be capped by the call option that you sell. 

The fourth disadvantage of the wheel strategy builds off the first disadvantage. The buying power reduction for stocks is around 50% when you use regulation T, but the buying power reduction when you sell out of the money put options is only around 15% or 20%. 

As a result, the amount of buying power that you’re going to use by being long stock can be about two and a half to three times more than when you sell an out of the money put option. 

The final disadvantage to running the wheel strategy is that during a prolonged bear market, you are going to lose money, dollar for dollar, by being long stock as opposed to when you sell options. 

When you sell options, you can actually roll down the strike price by about $5 or $10 by rolling it out in time, and you can oftentimes improve the basis of your strike price for ~20% - 30% of the strike price improvement. It’s common for you to spend around $2 or $3 in order to realize an incremental $5 or $10 of reduction in strike price of your put option, and that $2 or $3 can easily be captured by simply rolling out the option in time and extending duration. 

You can use the time premium and allocate that time premium to decrease the strike price on your put option by about $5 or $10. However, you will not realize this benefit when running the wheel strategy (because there is no expiration component when long stock). 

For every dollar that the stock decreases in value when you are long shares, you are going to experience a $100 decrease in your net liquidation value for every contract that you sold. 

Remember that one contract represents 100 shares of stock. If you are long stock and that stock decreases by $1, then your net liquidation value is going to decrease by $100, or the full extent of the decline in that underlying stock. 

However, if you’re selling options, you can reduce that strike price by about $5 or $10 simply by rolling forward that option in time.

Simultaneously, it will be a more efficient transaction because being short the options will use up about two and a half to three times less buying power than being long the stock. 

One of the problems of running the wheel strategy in a bear market is that you are going to end up taking assignment of a lot of stocks, which is going to end up using a lot of your buying power. 

The amount of premium you are going to collect by selling the call options is not even going to be close to the amount of losses that you will suffer in a bear market by being long all those shares of stock. 

Should you use the wheel strategy? 

To summarize, David Jaffee believes the wheel strategy is pretty good because it provides you with a win rate of about 60% to 65%. 

However, David Jaffee does not use the wheel strategy because taking ownership of stock is not capital efficient. 

Additionally, during a bear market, you are going to lose a lot of money by running the wheel strategy. The losses that you are going to suffer during a protracted bear market are not going to be able to be offset by selling call options. 

When you roll options, you are able to realize a significant improvement to your strike price by simply using the premium that you would receive from rolling it forward and allocating that towards improving the strike price. 

You can allocate that time premium towards your strike price to decrease the put option by about $5 to $10. You will only pay about $2 and you’ll be able to finance that $2 by simply rolling forward that option by a few weeks out in time. 

However, if you are running the wheel strategy, you do not have that advantage. For every $1 that the underlying stock falls, you are going to realize a relatively significant decrease in your overall P&L. 

David Jaffee of BestStockStrategy.com thinks the wheel strategy is worthwhile and relatively safe for people to implement. 

He does not incorporate the wheel strategy into his portfolio, but he does not think that the wheel strategy is a bad option trading strategy. 

Instead, David Jaffee prefers to sell options and teaches other traders to do the same. 

Visit BestStockStrategy.com to learn the best options trading strategy and receive $400 of free options trading materials.

Frequently Asked Questions (Wheel Strategy)

What are some other resources about the Wheel Strategy?

This is a good article about the wheel strategy

What are the typical wheel strategy returns?

You can earn an extra ~7% a year by "running the wheel". However, remember that there is no free money and you may be sacrificing some upside potential on your long shares by running the wheel strategy if your short call strike is penetrated.

What are the best stocks for wheel strategy?

Usually the best stocks for the wheel are stable companies with solid brands where you can sell far OTM call options while also capitalizing from the price appreciation of the underlying stock.

About the Author David Jaffee

I (David Jaffee) help people become consistently profitable traders while minimizing risk. I graduated from an Ivy League University and worked at some of Wall Street's most successful investment banks. Subscribe to my YouTube channel for valuable videos - BestStockStrategy YouTube Channel​. Finally, if you're looking to Land a Finance Job, then I've put together the best step-by-step course at LandaFinanceJob.com. My personal website is DavidJaffee.com.

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