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The Wheel Strategy

Tony Zhang
May 9, 2022
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8 minutes read
The Wheel Strategy

As an equity investor, we are always seeking investment opportunities to maximize capital appreciation and income. Finding a balance between the two can be challenging and many times have significant tradeoffs. However, you can potentially add income to any equity position with options using two strategies to add an income stream. Income can be supplemented during the stage of acquiring the stock, or during the holding period of the equity with a cash secured put and a covered call. When you combine both strategies on the same equity, we typically call this the Wheel Strategy. In this post we will explore the mechanics of this strategy and review examples of how you can potentially add income to any equity position. 

The Wheel Strategy can be considered both an income strategy and a stock acquisition strategy. This is because the Wheel Strategy combines selling Cash Secured Puts and Covered Calls. It is a long-term strategy that allows investors to systematically obtain stock at a discount (using Cash Secured Puts) and, in the event of getting assigned, purchase the stock at the short put strike and start selling Covered Calls to generate additional income. Before implementing the Wheel Strategy, investors should have a strong understanding of selling Cash Secured Puts and Covered Calls. There are essentially three steps to this strategy:

  1. Repeatedly sell Cash Secured Puts (and receive a premium) until assignment, where the shares will have to be purchased at the strike price.
  2. Sell Covered Calls to generate a consistent income until the stock is called away and the shares are sold at the strike price.
  3. Rinse and repeat this cycle.

This strategy allows investors to generate income in the form of premium while waiting to open a long position on 100 shares and, from there, generate even more premium by selling Covered Calls. When the shares are eventually called away, the investor will profit from the capital appreciation of the shares and the premium received along the way, as shown in the example below.

 

Example

$BMO is currently trading @ $100/share

Goal: To purchase $BMO at $98/share with a target of $110

 

 

In the above example, $BMO stock can potentially be acquired for $3/share cheaper than entering a buy limit order. The ideal outlook for this strategy is that the stock has a short-term retracement before continuing a longer-term rally. Investors should have a neutral/slightly bearish short-term outlook while having a bullish long-term view. If the strike price is not reached and there is no assignment, the investor will keep the premium received as an income. Cash Secured Puts can be rinsed and repeated each period to generate an income stream. If the stock is acquired at $98, the investor can start selling Covered Calls, which allows the investor to sell the stock after a sharp rally to maximize capital appreciation:

 

After acquiring the stock from selling the short put, the investor now owns 100 shares of stock $BMO with a current market price of $98

Goal: To sell $BMO @ $110 after rally

Sell $110 covered call @ $1

 

The profit from this strategy is the difference between the Put and Call strikes plus all the premium received. 

 

Limitations to the Wheel Strategy

  • Patience is required. Trades generally only execute at expiration.
  • Potentially miss out on some opportunities – if the price does not retrace, the investor will not be able to purchase the stock at a discount. Additionally, the price could rally well above the strike price of the covered call, which causes the investor to miss out on extra capital appreciation
  • Requires trading in 100 share increments

 

Best Practices and Tips

  • Use shorter-dated options to maximize time decay (4-7 weeks).
  • Use aggressive strikes (higher delta) for Cash Secured Puts.
  • Use conservative strikes (lower delta) for Covered Calls.
  • Use OptionsPlay’s Optimal Short Put and Covered Call Reports to find optimal candidates for the Wheel Strategy.

 

OptionsPlay’s Income Reports are designed to give investors the tools to use the Wheel Strategy effectively. Our Short Put Report allows investors to acquire stocks they wish to own efficiently. At the same time, the Covered Call Report provides the optimal strike and expiration to generate a consistent income stream. Both reports are updated daily and follow best practices while highlighting all relevant information such as raw/annualized returns, implied volatility, distance to strike, and a link to open the trade on the OptionsPlay platform! 

 

Optimizing the Wheel Strategy using OptionsPlay’s Income Reports:

 

 

Take advantage of free access to OptionsPlay Canada:

www.optionsplay.com/tmx 

 

 

Disclaimer: The strategies presented in this blog are for information and training purposes

only, and should not be interpreted as recommendations to buy or sell any security. As always, you should ensure that you are comfortable with the proposed scenarios and ready to assume all the risks before implementing an option strategy.

Copyright © 2022 Bourse de Montréal Inc. All rights reserved. Do not copy, distribute, sell or modify this document without Bourse de Montréal Inc.’s prior written consent. This information is provided for information purposes only. The views, opinions and advice provided in this article reflect those of the individual author. Neither TMX Group Limited nor any of its affiliated companies guarantees the completeness of the information contained in this publication, and we are not responsible for any errors or omissions in or your use of, or reliance on, the information. This publication is not intended to provide legal, accounting, tax, investment, financial, or other advice and should not be relied upon for such advice. The information provided is not an invitation to purchase securities listed on Montreal Exchange, Toronto Stock Exchange, and/or TSX Venture Exchange. TMX Group and its affiliated companies do not endorse or recommend any securities referenced in this publication. Montréal Exchange and MX are the trademarks of Bourse de Montréal Inc. TMX, the TMX design, The Future is Yours to See., and Voir le futur. Réaliser l’avenir. are the trademarks of TSX Inc. and are used under license.  All other trademarks used herein are the property of their respective owners.

Tony Zhang
Tony Zhang http://tmx.optionsplay.com

Head of Product Strategy for OptionsPlay

OptionsPlay

Tony Zhang is a specialist in the financial services industry with over a decade of experience spanning product development, research and market strategist roles across equities, foreign exchange and derivatives. As the current Head of Product Strategy for OptionsPlay, Tony leads the research and development of their OptionsPlay Ideas & Portfolio platform. He has leveraged his interest in financial technology and product development to provide innovative, reimagined solutions to clients and the users they seek to serve. Previously he spent 7 years at FOREX.com with a capital markets and research background as a market strategist specializing in equity and FX derivatives markets.

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