The Options Wheel Strategy Explained (with Spreadsheet)

Content

Introduction
Basic steps of the option wheel strategy
Key considerations and essential factors to keep in mind
Example with demonstration of tracking trades (spreadsheet screenshots)
Conclusion
My “Options Trading Wheel Strategy Spreadsheet” – for Excel and Google Sheets
YouTube DEMO Video

1. Introduction

The wheel strategy is a popular approach among investors and option traders for generating income through selling options and potentially owning stock.

This strategy offers a structured approach to selling cash-secured puts and covered calls within a well-thought sustainable and long-term trading framework. It’s ideal for stock investors seeking a seamless shift to options trading.

By studying the two previous chapters of this e-book, we’ve established the foundation for this strategy by examining cash-secured puts and covered calls earlier.

The options wheel strategy is well documented all over the internet, which demonstrates its popularity. In this document, I will focus on the key principles, the steps of this strategy and I will discuss some important considerations. I will also demonstrate the journaling of the wheel strategy trade, using a dedicated spreadsheet tool I’ve created, to track the strategy results.

2. Basic steps of the options wheel strategy

The options wheel trading strategy is a very systematic and strong trading strategy that can be a fairly profitable long-term trading strategy at relative low risk.

Basically, the options wheel strategy is quite simple: it is a trading strategy, producing a cashflow income, involving selling cash secured put options, potentially buying the shares, and selling covered calls against these shares, until they are called away and sold for a profit or until the short covered call position is closed. When the stock is called away, you can restart the process and initiate a new “wheel”.

Let’s delve deeper into the steps of the procedure.

Here are the 4 steps in the process:

STEP 1 : Begin by selling a put option for a selected stock, ensuring you have the cash to cover potential stock purchase. By selling this put, you receive a credit (premium) to your account.

STEP 2 : If assigned due to your short put option, purchase the shares at the contract’s strike price. If the put expires without any action (not closed early or expires worthless), you retain the credit from step 1 and you circle back to Step 1 and restart the process.

STEP 3 : Once you own the shares from Step 2, proceed to sell a covered call against those shares. Again, by selling this call, you receive another credit (premium) to your account. If the call option closes or isn’t executed (expires worthless), you retain the credit and repeat by selling another covered call.

STEP 4 : If assigned due to your call option, sell the shares at the contract’s strike price, and you retain the credit from the call option in step 3, and you go back to step 1 to repeat the whole wheel process, collecting more credits along the way.

Throughout this wheel strategy, each time you sell an option (either put or call), you receive a credit, enhancing your overall returns.

If the put option is assigned and the trader ends up owning the stock, they may receive dividends from holding that stock, provided the stock is a dividend-paying one. This makes dividend the third potential source of income, next to the put option and the call option premiums.

To fully understand this article, the basic knowledge of a put and a call option contract should be known. If this is not the case, or in case you need more explanations, you can find several basic articles on our website (I advise to first study these option basics).

Let’s delve into the various steps, and I’ll also showcase how to log the Wheel Strategy trades using a specialized spreadsheet tool I’ve designed to monitor the strategy’s outcomes.

3. Key considerations and essential factors to keep in mind

Before embarking on the wheel strategy journey, it’s crucial to factor in these considerations, ensuring a balanced approach between risk and potential returns:

a. Stock selection

It’s essential to select an appropriate underlying asset. My recommendation is to focus on these two key aspects:

Quality of Asset: Opt for high-quality stocks or ETFs only, the ones that you wouldn’t mind owning in your portfolio.
Liquidity: Choose assets with high liquidity to ensure tight bid-ask spreads, which can reduce the cost of entering and exiting trades, it will increase your profitability in the long run.

When determining the stock for your wheel strategy, it’s vital to narrow down potential candidates by addressing the following criteria:

(1) Stock Selection Criteria: Is this a stock you’d be comfortable owning at any given point?

Your response should resonate with a firm ‘yes.’

It’s paramount to pick stocks that align with your desire to either own or feel neutral about holding for the extended term. In essence, the Wheel Strategy leans towards a long-term perspective and position.

For my part, I gravitate towards stocks that I am wholeheartedly at ease with retaining for a duration surpassing two years. These are typically shares of companies rooted in robust sectors, exhibiting a reasonably foreseeable upward trajectory over an extended period.

A generous dividend is an added advantage (though not mandatory) since it offers an extra income channel, especially if the stock remains assigned for a considerable duration.

(2) Do you have the cash (and you won’t need it for a long time) to buy 100 shares of that stock?

Based on the total cash you’re willing to dedicate to the wheel strategy, you can determine the suitability of a particular stock as a candidate.

Ensure you have funds equivalent to 100 times the stock’s price and that this amount won’t be required for an extended period. To gauge this, simply multiply the stock’s price by 100.

(3) What is your directional bias for the stock?

Before selecting a stock it’s important to reflect on the long-term outlook on the stock or the overall market.

The wheel strategy is inherently bullish. When you’re selling cash-secured puts (step 1), you’re indicating a willingness to buy the stock at a particular price, implying you believe the stock won’t fall significantly below that price or, if it does, you’re comfortable owning it. When you transition to selling covered calls (after assignment), you still hope the stock price remains stable or grows, albeit not significantly beyond your strike price until you’ve accumulated enough premiums.

Given this structure, it’s crucial to have a bullish or at least neutral long-term directional bias on the stock you select:

Stock Fundamentals: choose stocks of fundamentally strong companies you believe will perform well over the long term. This belief acts as a safety net; even if the stock price drops temporarily, you trust it will recover.

Market Sector and diversification: it’s beneficial to select stocks from sectors that are expected to experience growth or stability in the coming years. This approach aligns with the long-term bullish bias. While having a bullish bias on individual stocks, it’s essential to diversify your portfolio to mitigate risks from any single stock’s adverse movement.

Economic & Geopolitical Factors: your bullish bias should also consider broader economic indicators and geopolitical events that could influence the stock’s performance.

In summary for stock selection: while the wheel strategy does involve short term option selling (puts and calls), the stock selection should be rooted in a long-term bullish perspective. It’s about balancing immediate premium collection with a confidence in the stock’s longer-term potential and stability. It is important to select a stock that will have a good chance to go up in the long run. A neutral to long bias is preferable.

b. Determining the strike price and expiration date of the CSP

When navigating the Wheel Strategy, judicious selection of the strike price and expiration date is pivotal to its success.

Selecting a strike price for the Cash-Secured Put (CSP) too close to the current share price can hasten assignment. Conversely, setting it too distant from the current share price, or too far out of the money, may yield minimal and too low premiums.

The chosen expiration date largely influences an option’s extrinsic value, which is shaped by both time value and the underlying stock’s volatility.

Research from Tastytrade suggests that the most opportune window for selling an Out of the Money (OTM) option is approximately 45 days to expiration. This period typically witnesses an accelerated rate of time value decay, implying that the option’s time value diminishes, during this time frame, more rapidly than options with longer durations.

Given the nuanced interplay of both factors, my personal selection criteria for CSPs are:

Expiration Date: roughly 45 days until expiration.
Strike Price Determination: a delta, as reflected in the options table, ranging from 0.16 to 0.30 (This provides a probability of 70% to 84% that the option will expire out of the money – OTM).

For position sizing, I generally lean towards selling only one option contract for each underlying. However, the actual number of contracts can vary based on the available cash and the stock’s price. For stocks with a lower share price, I might opt for more contracts.

The decision to close an option position before its expiration can be a point of debate, because the initial mindset was to be ok to buy the shares when assigned. Closing the position early has also its advantages, but I will not go into this topic in the context of the options wheel strategy.

c. Determining the strike price and expiration date of the CSP

Also, the meticulous selection of the strike price and expiration date for the Covered Call (CC) is paramount, for the success and profitability of the strategy.

Setting the strike price of the CC too close to current share prices can lead to unprofitable assignment, possibly resulting in a loss where the purchase price of the shares exceeds the selling price. Conversely, if the strike price is set significantly higher than current share prices, the resulting premium may be too low again. First step for determining a good strike price is calculating the cost basis of the assigned shares.

Calculating the actual cost basis to determine the strike price of the CC

The cost basis of shares in the Wheel Strategy refers to the purchase price of the stock, adjusted for any premiums received or paid through the options involved in the strategy.

It essentially determines the break-even price for an investor and is pivotal for calculating potential profits or losses, and thus also for determining profitable strike prices.

Here’s a breakdown of how the cost basis is determined in the wheel strategy:

Initial Cost Basis from Cash Secured Put option sale:
- When you start the wheel strategy by selling a cash-secured put, you receive a premium. If the put option is assigned and you’re obligated to buy the stock, the premium you received reduces the effective purchase price of the stock.
- example: if you sold a put with a strike price of $50 and received a $2 premium, and then get assigned, your initial cost basis for the stock would be $48 per share ($50 – $2).

Adjustments from Covered Calls:
- After owning the stock, if you sell covered calls against it and receive additional premiums, these further reduce your cost basis.
- Continuing with the previous example, if you sell a covered call and receive a $1 premium, your adjusted cost basis becomes $47 per share ($48 – $1).

Dividends and additional Costs:
- If the stock pays dividends while you own it, these can further reduce your cost basis.
- However, any costs associated with trading (like commission fees, if applicable) would increase your net cost basis.

The cost basis is crucial in the wheel strategy as it helps investors to assess their potential profit or loss for specific strike prices, when they eventually sell the stock or when options are exercised.

In the example above, after being assigned to buy the shares at $50, my overall cost basis for 100 shares of IBM was $48 per share (($5,000 – $200 premium received)/100).

This means whenever I sell a covered call and I would select a strike price below my cost basis, I run the risk to get assigned and not make an overall profit.

Let me demonstrate with an example.

Imagine the stock drops to $40 when I got assigned the stock. Now I want to sell a covered call with strike price $45 and I receive a premium of another $2. This brings my overall cost basis to $46. In case the share price moves up and above $45, I will get assigned to sell my 100 shares at the strike price of $45 and receive $4500.

In this case my net profit/loss will be :

-$5,000 (buy 100 shares) + $200 (premium CSP) + $100 (premium CC) + $4.500 (sell 100 shares) = -$200

So this is absolutely something we want to avoid or a risk that I need to take into account. And to make this analysis I need to always know the cost basis of my position.

Given the nuanced interplay of both factors strike price and expiration date, my personal selection criteria for CSPs are: 14 DTE and deltas ranging from 0.16 to 0.35 depending on the share price evolution and my cost basis.

It is possible that in some cases, I will want or need to sell a CC with strike price below my overall cost basis, but this is usually only the case the stock has dropped substantially. In that case the premium in the far OTM calls are not juicy enough. Hence the importance to select shares that are likely to move upwards.

It is important to be aware of this, and adjust your strike price according your intentions.

d. Mistakes to avoid

Maintaining clarity about your position’s status is crucial, as regular analysis and corresponding actions are often necessary.

This underscores once more the significance of a comprehensive tracking spreadsheet. Operating without such a tool can lead to bad decisions, which are best avoided. The reasons why I’ve created a dedicated spreadsheet.

It’s widely recognized that stock transactions come with inherent risks. Stock prices can plummet, potentially leaving me with devalued shares or compelling me to retain the shares longer than anticipated. However, in moments when share prices are in decline and assignments occur, it’s vital to stay calm and composed.

You started with a plan so stick to it!

It’s essential to recall the initial intent: desiring the stock. Now, there’s an opportunity to acquire those shares at a more favorable rate. If my initial sentiment towards the stock remains unchanged, owning it should be viewed positively. And even if the stock’s descent persists, it’s imperative to remember the commitment was long-term.

In essence, the wheel strategy shouldn’t be employed, and puts shouldn’t be sold on stocks you aren’t keen on owning. Adhering to this principle ensures peace of mind, eliminating any cause for unnecessary panic.

4. Example with demonstration of tracking trades

a. Step 1 : Selling a cash secured put (CSP)

The process starts with selecting an underlying stock which I wouldn’t mind owning or buying because my overall bias of the stock on the long term is bullish (it is wise to use only strong reputable stocks with and overall expectancy of the share price moving upwards).

Let’s take $IBM as an example.

So if I won’t mind buying the shares, I certainly won’t mind buying them at a lower price.

Also choose an underlying you can afford : your account value must be 100x greater than the price of stock (the reason is explained above).

Cash secured means that I, being the seller of the put options have the cash available in case I would get assigned and I have to buy the stock.

In this example, to be cash secured I have to keep $15,000 (column cash allocated) aside for this trade (transaction fees not considered).

On 1/4/23 $IBM was trading around $13, and I sold sell an OTM put, with strike price $124, with expiration 12/5/23 (around 45 DTE), and for selling this put right to the buyer, he pays me a premium of $1.78 per share.

I will receive in total $176 for selling the contract ($2 fees).

Let’s look at the possible outcomes.

First outcome : the option expires worthless and has no intrinsic value (out of the money – OTM)

Imagine that at expiration, IBM is trading around $125. This means that the owner of the put option will NOT execute his right to sell his 100 shares to us at the strike price of $124, because he can sell them in the open market for $125 ($100 more than selling to us). As long as the share price on the open market remains above the strike price of $124, the option contract has no intrinsic value and will expire worthless.

This would mean for me, as the seller of the put option, that the contract, and my short position, no longer exists and that my net result +$176, the premium received.

In this case, I can restart over and sell another cash secured put to receive more premium. You could also state that the general idea of selling a cash secured put is that you are getting paid to wait until you can buy the stock at a lower price.

Second outcome: the option expires with intrinsic value (in the money – ITM) and I get assigned. In this case we go to Step 2.

In this example I did get assigned because the price dropped below $124. So we go to step 2

b. Step 2 : Being assigned to buy the shares

At expiration, the share price moved down to $122.40 (ITM).

This means that the owner of the put option can and will execute his right to sell his 100 shares to us at the strike price of $124. He will absolutely do so because he can sell them to us for $1.60 more than what they are worth in the open market ($122.40). As long as the share price on the open market is below the strike price of $124, the option contract – the buyer has bought – has an intrinsic (real) value.

This means for me as the seller of the put option, that the contract will get assigned for execution, and that I will need to buy 100 shares of IBM at the contract strike price. I will pay 100 x $124= $12,400 + fees and I will receive 100 shares that are valued on the open market at that moment $122.40

So I did get assigned and bought the shares.

After assignment, the short position no longer exists (and is closed in the spreadsheet) and I add the buy transaction of the shares.

The spreadsheet calculates the net cost basis considering the purchase price, the received premiums, and the fees paid. The spreadsheet also calculates the cash balance, unallocated cash, share and option results separately and of course the overall net result considering the share price at that moment.

Now with the shares in my portfolio, I will proceed to step 3.

I am obviously hoping that the shares will rise, but I am also selling a covered call to receive extra premium – go to step 3.

c. Step 3 : Selling a covered call (CC)

I have now 100 shares in my portfolio. I am obviously hoping that the shares will rise above the initial buy price of $124 to make a profit on the buy-sell shares transaction. But I am also selling a covered call to collect more premium, which lowers my overall cost basis.

I prefer to have the strike price of the covered call minimum and preferably above the actual cost basis per share, which is at that moment $122.49 (see screenshot above)

I have a quiet positive outlook on IBM and sold an OTM call, with strike price $132, with 21 days until expiration (DTE), and a premium of $1.65 per share. I will receive in total $163 for selling the contract.

The stock remains below $132 at expiration so the position expires worthless. And I repeat the process of selling a CC.

I sell a CC at 133 strike price for $2.24 premium and DTE 14 days. Look at the situation with the stock price at $130. I make profit of the rise in share price and I profit of the premiums received.

Remember, “Covered” means that I have, as the seller of the call option, the shares available in my portfolio in case I would get assigned. Imagine if I don’t own the shares and will get assigned to sell the shares at strike price, then I will have to cover my position and buy the shares on the open market (at a higher price than the strike price) and sell them to the owner of option contract (at strike price), resulting in a negative transaction result.

In this example, I have my call position with strike $133 covered with the 100 shares of IBM.

Let’s look at the possible outcomes.

First outcome : the option expires worthless and the CC has no intrinsic value (out of the money – OTM)

Imagine that after 14 days at 16/6/23, IBM is trading around $131. This means that the owner of the call option will NOT execute his right to buy his 100 shares from me at the strike price of $133, because he can buy the shares in the open market for $131 ($200 cheaper than exercising the option contract). As long as the share price on the open market remains below the strike price of $133, the option contract has no intrinsic value and will expire worthles.

In case the option expires worthless (what happened with the first CC with strike price $130) the short position stops to exist and I can rinse and repeat step 3.

Second outcome : the CC option expires in the money and has intrinsic value (in the money – ITM) and I get assigned to sell the shares.

And this is what happens here. The share price goes up to $139 on 16/6/23 and I got assigned to sell the shares at the strike price of $133.

In this case we go to Step 4

d. Step 4 : Being assigned to sell the shares

I got assigned because the option has $6 of intrinsic value. After assignment, the short position (CC) no longer exists and my net result at that moment will be a positive P/L of $1,695

(-$12,400 (buy 100 shares) + $178 (premium CSP) + $163 (premium CC) + $224 (premium CC) + $13300 (sell 100 shares) – minus $49 fees) = $1,414

Imagine that I would have bought 100 shares initially at the moment of step 1 (share price was $132) and would have sold them also at step 4 (share price was 139), my P/L would have been $650 (fees considered), less than the profit I made with the wheel.

With the wheel strategy, I am less affected by down and up moves moves of the stock. I have to admit that I can’t benefit 100% of the up moves as well, but again if I would have a crystal ball…

The power of this wheel strategy comes from selling option contracts and receiving premium regardless of the share price movement. Selling options allows me to not be right all the time regarding the movement of the share price.

In this example I could not profit of a dividend payment, but I you run the wheel regularly as a basis strategy, this will happen now and then, adding premium and augmenting your return.

In summary, running the options wheel strategy is a great way to learn the basic about options trading (puts and calls mechanisms), and at the same time it allows to generate “relatively” safe income, experiencing real trades.

Of course, you must realise that options trading comes with a specific risk and you should know this risk exists before entering a trade. But the options wheel strategy, is dealing with cash secured puts and covered calls (no naked positions), which makes it much more conservative strategy.

5. Conclusion

The option wheel strategy is sometimes called the Triple Income or Triple Cash Flow strategy. It is indeed possible to have 3 income streams during the entire process of the strategy: premium of selling CSPs, the possible profit of a share transaction (buying low and selling higher) and premium of selling CCs. And when lucky, it is even possible to profit from receiving dividend when holding the shares.

This strategy fits the investor, who has sufficient cash available for a longer period, who is looking to buy a good stock , who wants to profit of buying the shares at a lower price, who wants to get paid while waiting, and once the shares owned, who is looking to continue generating income via selling premium of CC, lowering the overall or average cost basis per share.

Although the strategy is a relatively simple and very attractive process and strategy, every investor must realise that there is a risk involved, being that the stock price can drop, even significantly, during a certain period of time. In that case he will get assigned the shares, with the risk that the shares go even lower or that they don’t recover immediately, with the possibility having the capital locked or required until the position is closed, after recovering.

Hence to choose the right stock that you are comfortable with holding for the long term. Then there is nothing to worry about if you do get assigned during the process.

Another risk would be that if the stock price rises up significantly, you will miss out on a lot of gains as compared to if you just bought the shares directly. As mentioned above, this strategy is mainly for consistent cash flow and not to profit from big share price moves.

Therefore, first study the strategy, next apply the strategy with a smaller capital required to experience it with real trades and real money, and build from there.

Cheers and good luck.

My “Options Trading Wheel Strategy Spreadsheet” – for Excel and Google Sheets

Whenever you’re ready, here is how I can help you to improve your option trading:

For the option traders looking to track their options wheel strategy results and improve their trading, check out the EASY “Trading Options Wheel Strategy Spreadsheet”.

I truly believe that tracking my trades is paramount for decision-making and learning from mistakes. I use tracking spreadsheets for many things in life but certainly to track my net worth and to track my income and expenses and of course for my option trades.

To keep a good oversight of the options wheel strategy, I have developed an Excel and Google Sheets spreadsheet completely customised for this strategy. The spreadsheet makes it easy for investors to follow the process and record each and every transaction during the process and a great follow-up of the obtained results. It puts all the information, easily to access and to analyse together in one window, allowing me my options decision-making.

The spreadsheet is available in our shop for immediate download. You can find all features and benefits of this spreadsheet via this link: https://www.tradingoptionscashflow.com/product/trading-options-wheel-strategy-spreadsheet-google -sh eets-excel/

ATTENTION : This spreadsheet focuses on the wheel strategy alone. If you are interested in tracking all your option trades, then also take a look at the ALL IN Options Trading Journal – version 2024, integrating all strategies and all types of trades: https://www.tradingoptionscashflow.com/all-in-options-trading-journal-spreadsheet/ . It is wise to have a look at both spreadsheets before making a choice.

The screenshots in this article are coming from this “Trading Options Wheel Strategy Spreadsheet”

Options Wheel Strategy Spreadsheet – AMD example

The spreadsheet includes transaction data, calculations for commission fees, cash dividends, open options, cash allocation to short puts, net profit calculations for shares and options and annualised return on capital. Basically all you need to keep a good overview of the strategy.