Trading Strategies and ideas

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.

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.

The Wheel Strategy Outline

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’re not looking for ownership; they’re in the game for the premium income. Their focus is on selling Puts on high-quality stocks they wouldn’t mind owning momentarily, but their goal is to avoid assignment by choosing options that are likely to expire worthless. If they do get assigned, they sell Covered Calls at the same price they bought the stock, or slightly higher, aiming for the shares to get called away quickly. Their objective is to keep their capital rotating through new rounds of Put selling, without getting tied down to any particular stock.

How to Find the Best Stocks for the Wheel Strategy

Selecting the best stocks for the Wheel Strategy is an art in itself (almost), depending on whether you’re a long-term holder or a short-term trader.

Long-term holders

For long-term holders, stability is king. You should choose high-quality, fundamentally sound stocks that you wouldn’t mind adding to your portfolio. Here’s where you take the time to evaluate companies’ financials, their growth prospects, and industry trends.

Stocks like Apple (AAPL), Microsoft (MSFT), or Johnson & Johnson (JNJ) could be worthy contenders. You’d be happy to own these stocks at a discount, and while you wait, you’re earning premiums from selling Put and Covered Call options. It’s a win-win, isn’t it?

Short-term traders

Short-term traders would want to aim for stocks with high options liquidity and volatility. The higher the volatility, the higher the premiums you can command. Stocks in fast-paced sectors like technology or biotech, such as Tesla (TSLA) or Moderna (MRNA), might fit this bill.

However, remember that with higher rewards come higher risks. The key is to choose stocks you wouldn’t mind owning temporarily if assigned, and always have an exit strategy in place to manage the risk.

In both scenarios, an essential part of the Wheel Strategy is to sell options on stocks you’re confident about. Why? Because confidence breeds patience, and patience often leads to profit in the world of options trading.

How to Leverage Volatility to Trade the Wheel Strategy?

Now that we have established different mindsets on how to trade the Wheel strategy, let’s dive in deeper with the Short-term trader mindset.

The cool thing about trading options lies in the ability to sell “Volatility” and “Time value”. Combining the two will allow us to generate consistent income disregarding how the underlying stock performs. This is why the emphasis should be held on how Put options are sold in the first place.

Why Focus on Selling Put Options?

This is the part of the Wheel strategy in which we have the most power of control because we get to decide which strike to jump in.

Just like the real estate investment analogy “you make money when you buy a property”, for the Wheel strategy, “you make money when you sell Put”.

We can find underlying stocks with high IV percentile and options with enough time value for us to get a consistent return of 5% to 10% a month. The underlying does not necessarily need to be something you want to own, because the key focus is to NOT GET ASSIGNED and focus on profiting from the premium gained selling Put options.

Most people look for stocks that are trending and most talked about without thinking about IV percentile or time value. What they are doing is essentially the same as buying a promising stock but using the Wheel strategy to get a cheaper entry point, or selling Covered Call until the stock price rises to a point that they can make a huge profit.

As you can see, for people who focus on short-term options trading, selling Covered Call is an afterthought and should not be the main focus of the Wheel strategy. We sell Covered Calls because it will let us keep making money until the stock price recovers to the strike that we got assigned, and allows us to get out breakeven or even profit more when the stock price recovers.

How to Find Stocks with High Implied Volatility (IV) for The Wheel Strategy?

The Concept

1) Find High IV Percentile Underlying Stocks

IV changes all the time based on what is going on in the market. News (good or bad) could change IV. IV also tends to spike before earning calls.

2) Choose the Right Expiration (Time Value)

Some expiration date is better than others. Maybe there is a product launch in 60 days. A phase 2 drug trial completing in 45 days. Check options close to 30 DTE (Day to Expiration) as a benchmark or even weeklies if there is one and calculate the “Monthly ROI”. Calculate the ROI for the shorter DTE Put option vs the longer DTE Put option. Choose the one that would allow you to get a 5% to 10% monthly return.

For example, ROI for a Put option strike price of $5 with 0.5 premium and 30 DTE is approximately 10% ROI per month using Cash Secured Put. Calculation based on 30 days = 1 month.

How to Set Up Options Scanner to Find High IV Underlying?

I use Thinkorswim and it comes with a powerful scanning tool. It allows me to combine multiple criteria for Stock, Option, and various Studies (image below). The setup I am sharing here focuses on low-priced underlying because even though I have a margin account, I still like to focus on what it would cost to hold the entire position. This forces me to not take way too many risks and keeps me grounded, which means I cannot open a large position for high-priced underlying.

In other words, if I want to aim for a 10% return per month, I need to find a lower-priced underlying to get higher returns.

I must point out that carrying out fundamental analysis is recommended to make sure the company isn’t going bankrupt in the near future or the stock isn’t having a reverse split soon. Technical analysis (such as Trade Apgar Score) is also recommended.

scan for wheel strategy

Open interests (Option)

This is essentially equivalent to “volume” for options. If there are more open interests, likely less slippage and easier to buy and sell options.

I set it to 500.

Last (Option Last Traded Price)

This is set to 0.4 because I am looking for a very low strike price option with a high return.

For example, a strike price of $5 with 0.4 is equivalent to putting $500 down to get $40 in return, which is 8%. If you use a margin account, that ROI will go even higher.

As an example, BCLI fits very well with these criteria. Thanks to its really high IV, $500 down to get $195 profit in about 60 days (image below). That is about 19.5% ROI per month.

bcli iV for Dec

Option type (Option)

Set this to Put only, since we are looking for Put options.

Days to Expiration (Option)

Set to 69 days. The longer the DTE, the higher the premium. This is why it’s set to about 2 months since we want to look for opportunities that would provide 10% per month ROI.

Strike (Option strike price)

Below 7. Could be a little higher but if it’s set too high, it will not give enough ROI.

Example: Stike 8 with 0.4 = $800 down to get $40 in return. That is a 5% ROI.

Volume (Stock volume)

Set to 130,000. Underlying with high liquidity (popular stock) also likely means options with high open interests.

Last (Stock price)

At least $1. If you are a risk-taker, stock hovering around $1 tends to have a pretty high IV.

IV Percentile (Study filter)

Between 49-100%.

Stocks for the Wheel Strategy Scan Result

Based on the day this scan took place (10/24/2020), 12 stocks match the criteria.

NOTE: While the setup above does not contain an Implied Volatility (IV) filter, all the stocks found by the scan happened to have an ImpVolatility higher than 1 in this example. In case the scan result contains low IV stocks as well, I would just use the sort function to look for high IV stocks.

Alternatively, you could add an IV filter to the setup above so the result would only contain the IV level you specify.

wheel scan result

Wheel Strategy Returns

The Wheel Strategy’s performance varies based on certain factors:

  • The total premium collection: The total amount of premium collected as options expire worthless plays a significant role.
  • Predicting price fluctuations: The ability to anticipate trends in the underlying price can significantly enhance profitability. The strategy hinges on the adage “buy low and sell high.” Consequently, selling puts when prices are at the lower end of the range and calls when prices are at the high end can dramatically improve returns. Technical analysis could help improve the odds.
  • Timing implied volatility: The timing of selling options is crucial, especially when the implied volatility is high by historical standards. Selling options in such scenarios can yield significant profits.

How To Manage Losing Trades For The Wheel Strategy?

Video Notes

  • Define When You Plan to Get Out
    • Price / Time Frame
      • Technical Analysis / Fundamental Analysis
  • Define what you will do
    • Selling Put
      • Let it get assigned. (Under Valued)
      • Roll it out? (Under Valued)
      • Close the Trade? (IV Play)
    • Selling Covered Call
      • Let it get assigned. (Under Valued)
      • Roll it out? (Under Valued)
      • Close the Trade? (IV Play)
  • Define Market Conditions
    • Closeout everything?
  • Follow Money Management (only risk x% per trade)
    • Look for underlying that you can afford based on your account size
  • Understand Your Win / Loss Ratio
    • Helps you to think logically

My Personal Experience with the Wheel Strategy

When it comes to trading styles and strategies, they can be grouped in so many different ways. Day trading, Swing trading, Momentum trading, Scalping, etc.

To me, all of these types of trading sound hectic. They all require active monitoring of stock price, stock movement, stock news, etc. I have personally tried a few of these and they have never really worked out for me. Don’t get me wrong, they work for some people but are not a good match for my personality.

I started out trading penny stocks and eventually made my way to Indexes and ended up trading options.

Over the years, I have tried many different types of options trading. Some required more work than others. Some have a higher probability of success than others. Some are premium selling and some are premium buying.

As you can see it was not a straight path for me to get to the Wheel strategy. It was a lot of trial and error before I ended up realizing the Wheel strategy is one of the most profitable ways to trade.

5 Reasons Why I Love the Wheel Strategy

1) It doesn’t require me to sit in front of the computer all day long

For some people, trading is just another job. They want to make a lot of money FAST. They looked for ways to trade as much as they could and most of them ended up day trading. I am not looking to have another job. I am looking for ways to NOT have a job. The wheel strategy allows me to do just that. Place the trade and I can walk away for a while.

2) It doesn’t require my attention all the time

Trading the Wheel strategy is relatively simple. Find good stocks that you wouldn’t mind owning for a while and make sure to choose ones that are unlikely to go bankrupt or reverse split in the near future. Once you have done your homework and placed the trade, that’s it. Just monitor the price once in a while until expiration.

3) It doesn’t make me stressed out or drenched in adrenaline all day

Trading should not be exciting. If you are looking for excitement, go do something else. We trade to make money, that’s it. There is no need to get stressed or drenched in adrenaline. Do the homework, place the trade, then close the position when the time comes. That’s it.

When placing trades for the Wheel strategy, I already know when I want to get out. If I get assigned, I would just calmly place a Covered call order and wait for it to get assigned. Yes, the stock price might go beyond the strike price. Yes, the stock might go much lower than I anticipated. I am okay with that because I have already taken those factors into consideration/calculation before I placed the trade.

4) It has a high win rate

The term “win rate” might be different from person to person because some people might count on getting assigned a “loss”. The way I count it is based on PNL. Even if my positions get assigned, as long as I manage to sell the stock above the entry point I consider it a win, because the overall PNL (sold PUT, sold Call) is positive.

Based on my trading record in 2020, the win rate is 89% for the Wheel strategy.

Having said that, it became a bull market in late 2020 after a significant dip at the beginning of the year due to Covid-19 so this was not surprising (the Wheel Strategy typically is highly correlated to how the market performs).

5) It’s easy to understand and manage

Have you ever tried to roll up or down an Iron Condor or a Double Diagonal Calendar spread? So many legs we have to figure out what to do with those. I was into trading those at one point because Iron Condor is ideal for high volatility trades and Calendar spread is ideal for low volatility trades.

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9 replies
  1. Bryan
    Bryan says:

    Hi ,i like everything that you wrote here,i learnt new knowledge from here. Any way can join your discussion room or discord?

    • Tony
      Tony says:

      Hi Bryan,
      Thank you for asking but I do not provide a discussion room or discord service.
      If you have a question please feel free to post it here in the comment or send me a message using the contact us page. I will do my best to answer your questions.

  2. b-lambda
    b-lambda says:

    Thank you for this. I’ve just gotten back into investing after selling my home, but have to admit, for all my previous experience, CSP’s were a new concept, and the missing piece it turns out. Love CSP’s! When I put everything together and saw it work, though, my thought was, “Why isn’t everyone doing this!? They must just love sweating the market from 9:30-4 every day.” Having just gotten started on it, it’s reassuring to hear from others who are using it. Anyway, my question for anyone and everyone is this: have you come up with a good screen to find securities with attractively-priced options? So far I’m finding that volatility and volume should be part of it. But that still means going through a lot of duds to find the diamonds.


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