Wheeling Strategy (Options Strategy)

The Wheeling strategy is a simple yet effective options trading technique. 

Based on selling put options and covered calls, this cyclical strategy allows traders to generate income regardless of market trends. 

Here, we’ll look at how the Wheeling strategy works, its risks and rewards, and how to use it.

Key Takeaways – Wheeling Strategy (Options Strategy)

• Two Steps – 1) Sell puts on a stock/asset you’re willing to own. If assigned… 2) Sell a covered call on the shares at the same (or higher) price as the put.
• Cyclical Income Generation – The Wheeling strategy cycles through selling puts and covered calls, providing consistent income regardless of market direction.
• Capital Requirement – This strategy requires enough capital to cover 100 shares of a stock, making it suited to accounts with higher funding.
• Risk and Reward Balance – By selling options on stocks you’re willing to own, risk is managed while capital gains and premiums can improve returns.
• Tax Implications – Short-term option premiums are taxed as ordinary income, impacting post-tax returns, especially with frequent trades.

Options Expiration Statistics

Most options don’t reach exercise.

According to CBOE data, only 10% are actually assigned, while up to 35% expire worthless.

This is relevant to the Wheeling strategy because the strategy looks to harvest the premiums collected from selling options that often expire without assignment.

This foundation of data helps traders understand how likely they are to keep their premiums or face stock assignment.

Basics of Option Trading Strategies

There are various ways to make money with options – each with varying risk and reward profiles.

Ideally, it should fit into a broader, well-structured portfolio.

Here, we’ll review a few simple approaches, leading up to the Wheeling strategy.

Credit Spreads: A Low-Risk Starting Point

One of the simpler options strategies is the credit spread, a defined-risk, defined-profit strategy. 

In a credit spread, traders simultaneously buy and sell options at different strike prices. 

The premium collected from the sold option offsets the cost of the bought option, creating a net credit. 

Credit spreads, particularly call and put spreads, are popular with new traders because they allow for controlled risk exposure with limited capital.

• Advantages – Defined risk; premium collected upfront; low capital requirements.
• Disadvantages – Limited profit potential; requires understanding of strike selection and market movement predictions.

Selling Naked Puts: A Step Up in Risk

Another strategy often considered in options trading is selling naked puts, where a trader sells a put without owning the underlying stock. 

This approach carries a lot of risk if the stock price falls below the strike price, given the trader has to then purchase the stock at that strike price.

Losses can pile up if the stock continues to decline.

• Advantages – Simple; premium collected if the put is not assigned.
• Disadvantages – Potential for significant downside loss; requires substantial capital for assignments.

The Wheeling strategy builds upon the concept of selling puts, but it takes a cyclical, calculated approach to limit risk and optimize profit potential.

So, let’s get into the actual strategy…

The Option Wheeling Strategy: A Step-by-Step Guide

What is the Wheeling Strategy?

The Wheeling strategy is a two-step process that involves selling put options on a stock to collect premiums and then, if assigned, selling covered calls on the stock. 

If done correctly, it provides a consistent way to generate income. 

Step 1: Selling Put Options for Premium Income

The first step in the Wheeling strategy is to sell a put option on a stock.

By doing so, the trader collects a premium (payment) for taking on the obligation to buy 100 shares of that stock at the strike price if assigned.

1. Select a Stock and Strike Price – Choose a stock you’re willing to own and an option strike price near or below the current stock price. Ideally, pick a stock you “believe in” – i.e., has strong fundamentals and would likely recover if it dips temporarily.
2. Collect the Premium – Upon selling the put, you receive a premium. If the stock remains above the strike price by expiration, the option will expire worthless, and you keep the premium.
3. Repeat or Prepare for Assignment – If the option expires worthless, you can repeat the process with a new put option, continuing to collect premiums. However, if the stock price falls below the strike, you may be assigned 100 shares at the strike price.

Step 2: Assignment and Selling Covered Calls

If assigned, you now own 100 shares of the stock at the put’s strike price.

The second step in the Wheeling strategy is to sell a covered call on those shares.

1. Sell a Covered Call – Sell a call option at a strike price slightly above the current stock price to collect a premium again. This step allows you to generate income while holding the stock.
2. Outcome Scenarios:
   • Option Expires Worthless: If the stock price doesn’t reach the call’s strike price by expiration, the option expires worthless, and you keep both the stock and the premium.
   • Option is Assigned: If the stock price rises above the call’s strike price, the option may be exercised, and you sell your 100 shares at the strike price. This “calls away” the shares, completing one full cycle of the Wheeling strategy.
3. Re-initiate the Cycle – After the covered call is assigned, you are free to start the process over by selling a new put option, effectively “wheeling” the strategy forward.

Wheeling Strategy in Action: A SPY Stock Example at $500

Let’s look at the Wheeling strategy using SPY trading at, e.g., $500 per share.

Scenario Setup

Assume SPY is trading at $500 per share, and you begin by selling a $495 put option expiring in one week. This put option offers a premium of $5 per share (or $500 for one contract, which represents 100 shares).

1. Selling the Put Option: By selling this put option, you collect a premium of $500. However, you need $49,500 in your account (if cash account, less if a margin account) to cover the purchase if SPY drops below $495 and you’re assigned 100 shares at that strike price.
2. Outcome Scenarios: At expiration, the option will either expire worthless or be assigned, each leading to different actions in the Wheeling cycle.

Outcome Scenarios

Scenario A: The Option Expires Worthless

If SPY’s price remains above $495 at expiration, the put option expires worthless.

In this scenario, you keep the $500 premium for a return of approximately 1.01% on the $49,500 capital at risk, all earned over a short period without needing to purchase the stock.

Scenario B: You Are Assigned the Stock

If SPY’s price falls below $495, you are assigned 100 shares at the $495 strike price, resulting in a total investment of $49,500.

Now, you own SPY shares, setting you up for the next step in the Wheeling strategy.

Step 2: Selling a Covered Call on SPY Stock

After being assigned 100 shares of SPY at $495 per share, the next move is to sell a covered call option on those shares to continue generating income.

1. Selling the Covered Call: You sell a $505 call option expiring the following week, collecting an additional premium of $4.50 per share (or $450 for the contract). This premium provides further income from holding SPY.
2. Outcome of the Covered Call:
   • Option Expires Worthless: If SPY’s price stays below $505, the call option expires worthless, allowing you to keep both the $450 premium from this call and the 100 shares of SPY.
   • Option is Assigned: If SPY’s price rises above $505, the option is exercised, and your shares are “called away” at $505 per share. In this case, you sell your 100 shares at the higher strike price, locking in a gain on the shares as well as the premium from the covered call.

Repeat the Cycle

Once the shares are sold, you have returned to your original cash position and can start the process over by selling another put option. 

This repetitive cycle of selling puts, buying shares if assigned, and then selling covered calls creates a stream of income with the Wheeling strategy.

Of course, there’s no profit guarantee, like any strategy, but for income-focused traders, it can be an option.

Advantages and Risks of the Wheeling Strategy

Benefits of the Wheeling Strategy

1. Consistent Income – Through the premiums collected from puts and calls, traders can earn consistent income (not necessarily profit).
2. Potential for Capital Gains – If assigned a stock that appreciates, selling the shares through a covered call generates capital gains in addition to premiums.
3. Controlled Risk with Defined Capital Requirements – Choosing stocks with strong fundamentals can help you reduce the risk of large losses. This way, you’re only exposed to stocks you’re willing to own.

Risks and Considerations

1. Capital Requirement – The Wheeling strategy requires enough cash to cover 100 shares of a stock upon assignment. This makes it more suitable for accounts with adequate capital.
2. Market Downturns – If a stock drops significantly below the strike price, you may be holding a loss on the stock even with premium income.
3. Opportunity Costs – While selling covered calls, you limit upside potential if the stock appreciates sharply. Moreover, short-term gains from premiums are typically taxed as ordinary income. This impacts after-tax returns.
4. Losing Money on Strike Differentials – If you’re assigned a stock and lose money in the process, you might lock in a loss if your strike price on the call is lower than the strike on the put. We’ll cover this more below.

Key Consideration: Don’t Lose Money on the Strike Differentials

In the Wheeling strategy, once you’ve been assigned stock through a sold put, it’s important to sell the subsequent covered call at the same or a higher strike price than your original purchase price (the put strike price).

(An exception could be if the analysis changed.)

This is done to avoid incurring a loss due to strike price differentials.

If you sell the covered call at a lower strike than what you paid for the stock, you risk locking in a loss if the stock rises and the call is exercised.

For example, if you’re assigned 100 shares of a stock at $50 and then sell a covered call with a $48 strike price, you’re agreeing to sell the shares at $48 – lower than your original $50 purchase price, resulting in a loss of $2 per share.

Setting the call strike at or above your purchase price, you ensure that any gain you make is derived from the premium collected (along with any potential price appreciation if the stock is called away).

This practice safeguards the core benefit of the Wheeling strategy – i.e., generating consistent income while maintaining the potential for capital appreciation without risking a loss on the shares due to unfavorable strike differentials.

Conclusion: Is the Wheeling Strategy Right for You?

The Wheeling strategy is a straightforward options trading strategy for generating income with manageable risk. 

Traders create a cyclical income stream while gaining exposure to stocks they may be willing to hold. 

It does require trading capital and a disciplined approach to selecting stocks and managing trades.

For those comfortable with the potential of stock assignment and trying a steady income approach to options trading, the Wheeling strategy could be an option.