The options wheel strategy utilizes options trading to generate consistent monthly cash flow. By selling covered calls and cash secured puts, this options income strategy offers a hands-off way to earn premium selling income while taking less risk than buying options. If done correctly, the options wheel can provide portfolio diversity, downside protection, and attractive risk-adjusted returns.
Disclaimer: This information is general in nature and for informational purposes only. It is not personal financial advice and has not taken into account your personal financial position or objectives. Make sure to refer to a licensed financial or tax advisor.
Table of Contents
Overview of the Options Wheel Strategy
The options wheel, also known as the triple income strategy, is a premium selling technique that generates income from stocks you already own or don’t mind owning. It works by selling covered calls against stocks you currently hold, or cash secured puts against stocks you want to hold.
You “wheel” in and out of stock positions, collecting income, reducing risk, and giving yourself time to be right on the stock selection. This systematic, rules-based approach offers a emotionless way to earn monthly residual income in sideways, up, or down markets.
How the Options Wheel Strategy Works
The options wheel strategy follows this four step process on repeat:
- Sell cash-secured puts on a stock you want to own, collecting premium
- If assigned on the puts, sell covered calls against the stock, collecting more premium
- If stock gets called away, repeat step 1 by selling more cash secured puts
- Manage positions by rolling, closing, or letting expire
Essentially, you are selling options to collect premium rather than buying them. By practicing defined, disciplined risk management, you provide some downside cushion in case the trade moves against you.
This conservative income approach aims for consistent monthly returns while reducing volatility and drawdowns. Patience and discipline are required to run this passive wheel over time.
Selecting the Right Stocks
Choosing suitable stocks is an important part of effectively running the options wheel. Look for stocks that meet the following criteria:
- Solid Fundamentals – Profitable companies with good fundamentals
- Healthy Liquidity – High options volume and tight bid/ask spread
- Neutral to Bullish Sentiment – Stocks you don’t mind holding long-term
Additionally, technical analysis can identify good wheel candidates trading in a predictable range while exhibiting the following technical signals:
- Defined Support and Resistance Levels
- Strong Chart Patterns like Channels or Flags
- Favorable Trends and Moving Averages
Selecting stocks with solid fundamentals that also demonstrate favorable chart patterns combines fundamental and technical analysis to give the highest probability wheel trades.
How to Screen for Suitable Options Wheel Stocks
Use stock scanning tools to filter the universe of stocks based on fundamental and technical factors that make good wheel candidates. Some key screening criteria includes:
- Share Price – $10 to $100 per share range
- Market Cap – Typically over $2 billion
- Volume – 500k min average daily volume
- IV Rank – Under 50% is favorable for selling
- Industry – Stable industries like consumer staples
Setting up alerts and screens will source favorable wheel stocks and options to trade each month. Pay attention to earnings dates and be wary of selling options through binary events.
The Most Reliable Blue Chip Stocks for the Wheel Strategy
There are some very reliable blue chip stocks that lend themselves well to using the the wheel strategy, and these are established, blue chip companies. Here are some of the most reliable ones:
Johnson & Johnson (JNJ) – A leading healthcare conglomerate with a diverse business model and over 130 years of history. JNJ offers stability with a 2.7% dividend yield. If you sell a cash-secured put below JNJ’s current price of $175, you could potentially get assigned stock at a discount or keep the premium if the option expires worthless.
Procter & Gamble (PG) – The consumer staples giant has paid a dividend for 130 consecutive years. PG sells products people need no matter the economy, making it resilient to downturns. Sell an out-of-the-money put and if PG stays above the strike at expiration, the option expires worthless and you keep the premium.
Coca Cola (KO) – The iconic beverage maker has an excellent track record of steadily increasing its dividend. KO shares tend to fluctuate between predictable ranges, ideal for selling call options. If KO stays below the call strike, the option expires worthless and you profit.
McDonald’s (MCD) – The fast food leader features recession-resistant demand and a reliable dividend payout. When assigned MCD stock from a put sale, you can generate income selling covered calls. If the call option expires in-the-money, get assigned and sell puts against MCD again to repeat the wheel.
Reliably profitable blue chips with healthy dividends optimize the options wheel strategy. The key is picking stocks you want to hold long-term, as you may get assigned shares at any time.
Position Sizing in the Options Wheel
Proper position sizing is critical in order controlling risk across the portfolio of wheel positions. Consider allocating no more than 5% of capital to each options trade.
With defined risk trades like credit spreads, allocate 1-2% of capital. For undefined risk trades like short puts and covered calls, allocate 3-5% of capital.
This ensures no single trade outcome heavily impacts the portfolio while diversifying across 20+ uncorrelated wheel positions.
Appropriate position sizing also allows earnings enough opportunities to compound over time while preventing overtrading that may exceed capital requirements or margin limits.
Managing the Trade from Both Sides
The key to running this options wheel strategy smoothly over time involves proactively managing positions from both the put side and the call side.
Once you sell a cash secured put, have a plan ready for if the stock drops below the strike price and gets assigned. This means preparing to sell covered calls by identifying the next earnings date, picking suitable strikes, and estimating probable monthly yields.
Likewise, have an early assignment plan in place when selling covered calls against stocks you already own. Know your profit targets, downside risk tolerance levels, and be prepared to buy back the calls, roll them out in time, or buy more protective put options.
Actively planning next moves from each wheel position reduces chance of getting caught off guard by fast markets. Patience pays off hugely when wheeling quality stocks and managing trades before expiration gets too close.
Risk Management Rules for the Options Wheel
The options wheel strategy concentrates risk into individual stocks, so prudent risk management across the portfolio helps sustain consistent income streams without blowing up the account on one trade gone wrong.
Some key risk management guidelines:
- Close positions at 50% max loss
- Buy back short options on extreme moves
- Hedge Black Swan risk with index put options
- Reduce positions before binary events
- Avoid earnings plays until consistent
The options wheel works best under a rules-based system with pre-defined actions for managing trades when they move for or against you. Executing this disciplined process over a portfolio of uncorrelated trades allows earning attractive risk-adjusted returns.
Results to Expect When Running the Option Wheel
Exact returns depend greatly on market conditions and management ability, but the options wheel strategy can target 8-20% unlevered annual returns through sideways, up, or down markets.
More importantly, it provides consistent weekly to monthly cash flow. Aim to generate 1-3% portfolio returns each month selling options. Over a year, compounding these small consistent gains generates significant income.
Because premium selling is a positive theta strategy, the unseen passage of time works in your favor as options decay towards expiration. Time premium erosion allows capturing income without strong directional movements.
Conservatively run over quality stocks with disciplined trade management, the option wheel strategy provides attractive risk-adjusted returns while smoothing out portfolio volatility.
How Much Money do I need for Options Wheel Trading?
So, for those startign out, here’s the biggest catch…investing in the options wheel strategy is not free. It requires some money.
In fact, you will need You will need a decent amount of collateral to sell puts and calls, so start saving up!
For example, if you want to option wheel AMD stock, you will need ~$10,000 to sell one put contract. Why? Because, if your trade goes against you, you will be forced to buy 100 shares of that AMD stock (100 shares x $100 stock price).
That’s why you should follow these two golden rules of options selling…
It is incredibly important to never sell puts on anything that you a) don’t have the cash to buy and b) do not mind owning 100 shares of.
In the AMD example, if you do not get assigned (i.e. are not forced to buy the stock), you could generate $400 per month or $5,000 per year in the premiums by selling weekly options. That’s enough to buy a lot of pizza and beer!
Just remember, the options wheel strategy is not a YOLO type of investment!
Mixed with a stock investing approach, the options wheel strategy could be a very lucrative way to generate consistent income.
Getting Started with Paper Trading
When executed properly following the core guidelines, the options wheel strategy offers an excellent hands-off income stream for part-time and full-time investors alike.
Before running real capital through the wheel, master the mechanics using paper trading platforms. Virtually trade options strategies without risking money to consistently profit from market moves in any type of market environment.
Various paper trading platforms provide historical and real-time data to practice visually backtesting your wheel strategy. Run your rule-based system through different stocks, trending and non-trending markets while tracking detailed performance analytics.
Paper trade for 1-3 months until achieving an edge. Profitable simulated trading ensures you have the skills, knowledge and experience needed to successfully wheel options income strategies.
Conclusion
For investors seeking portfolio diversity and sustainable cash flow, the options wheel strategy uses covered calls and cash secured puts to generate consistent monthly income. By selling time premium, you collect weekly to monthly payouts without needing strong directional stock moves.
Conservative position sizing, balanced trade allocation, and disciplined risk management allows smoothly running this wheel strategy across bull, bear, and sideways markets. Master the probabilities, mechanics, and emotions required through paper trading to ensure you have an edge before placing real capital at risk with the options wheel. And follow the golden rules: only sell put options on stocks that you have enough capital to purchase if the trade goes against you and on stocks that you don’t mind holding.
