How to Find the Best Stocks for the Wheel Strategy with Volatility In Mind?

Are you a trader looking for a strategy that can provide recurring income? Then the options wheel strategy might be just what you need. This popular trading technique involves using option contracts to generate consistent profits from underlying stocks.

Table of Contents

Understanding the Wheel Strategy

Step 1: Sell a Put Option – The first step in the wheel strategy is selling a put option on a stock that you are interested in purchasing at a lower price.
Step 2: Receive Premium – By selling the put option, you receive a premium from the buyer. This premium acts as an income for you, regardless of whether the option is exercised or not.
Step 3: Await Assignment – If the stock price drops below the strike price of your put option, you may be assigned to buy the stock at that lower price. This is where the wheel strategy gets its name from, as it “wheels” around in a cycle.
Step 4: Sell Covered Calls – If you are assigned the stock, you can then sell covered call options on it to generate additional income.
Step 5: Repeat the Cycle – If the stock is not assigned, you can continue repeating this cycle of selling put options and covered calls to earn recurring income.

Let’s visualize this Wheel Strategy with an example

Step 1: You sell a put option with a strike price of $48 and receive a premium of $2 per share.
Step 2: You pocket the premium which acts as your income – that’s $200 (since one option contract represents 100 shares).
Step 3: The stock price dips to $47 at expiration. You are now obligated to buy 100 shares of Company X at your strike price of $48, even though it’s trading at $47.

But don’t worry – remember that $2 per share premium you collected? That effectively reduces your cost basis to $46, so you’re still in a profitable position.

Step 4: Now that you own the shares, you decide to sell a covered call with a strike price of $52, receiving another premium, say $1.50 per share.
Step 5: If the stock price rallies past your strike price, the shares will be called away. But, you’ve made a profit from the $4 increase per share, plus the premiums collected from the put and call options. If the stock price doesn’t reach $52, you keep the shares, retain the premium, and can sell another covered call.

Two Ways to Trade the Wheel Strategy

When it comes to trading options, you’ve got two main types of traders utilizing the Wheel Strategy – those eager to own the underlying asset, and those who’d rather not.

Long-term holders

Options traders with long-term time horizons in mind are essentially looking for a price discount on a stock they’ve been eyeing for a while. They view any assignment of shares as a golden opportunity instead of a setback. They sell a Put option with a strike price close to, or even below the current market price, eager to get assigned.

Once they own the stock, they proceed to sell Covered Calls at a higher strike price, securing premium income while they wait for the stock to appreciate. And if their shares get called away? They simply rinse and repeat the process, always content in the knowledge that they are buying stocks they want to own at a discount, and making money while they wait for the right price to sell.

Short-term traders

They&