Trading Stock Options with The Wheel 🚀

Photo by Jason Briscoe on Unsplash

Ever since I started trading stocks, I’ve always had the classic mentality of…

buying the S&P 500 Index— closing my computer and throwing it out the window — and then checking out the juiced-up folio 30 years later.

And even though I completely agree with this methodology of buying and holding, I believe that having some fun and supplementing this action can actually be healthy.

The most obvious visualization of buying and hold is if you had just bought $10,000 worth of TSLA when it first became public, your investment would have been worth almost $2 million today: a 22,000% percent gain.

Intro to the Wheel

This is a basic strategy that implores assumptions of prior knowledge about options and their mechanics. This guide is not mean’t for in-depth knowledge but to help build a foundation for monkey understanding.

The Wheel involves the use of SELLING options contracts and NOT BUYING.

This means when operating the wheel, we primarily use Cash Secured Puts and Covered Calls.

• Cash Secured Puts net you a credit from creating a contract using collateral from your base strike while
• Covered Calls also net you a credit while using existing owned shares as collateral.

How To Wheel ☸️

Now that we understand what we’ll be using let’s dive deeper into executing the wheel.

As the name suggests, the wheel is like a cycle, it farms premium with inevitable entries and projected exits.

Starting off the wheel, because CSPs allow us to buy shares at our designated short put strike price, generally speaking we only run the wheel on shares that we don’t mind getting assigned.

We get to keep the premium from selling that contract and eventually end up with 100 shares times # of contracts.

However, when holding onto a CSP the contract doesn’t necessarily have to be held up until the very last moment. From the time that you sold until expiration, numerous amounts of factors have eaten away at the value of that contract to the downside.

This means that from the time that you sold, you can close out your position by BUYING TO CLOSE that contract.

(Ex. Sell To Open CHPT 4/16 25p: $2.00, Buy to Close Value: $0.75->$125)

This is the most desirable outcome as you come out with a quick profit and don’t have to risk getting assigned shares despite the fact that you’re long-term bullish.

But if you do get assigned what comes next???

The next step is to start selling covered calls on your shares using shares acquired from the CSP as collateral.

Doing this will net you a premium and if the underlying shoots past your strike by which you sold, you collect the capital gains + premium from CC.

This would complete your overall wheel as your shares have now entered and exited from your portfolio.

In the process, you’ve collected premium on your desired stock and have completed one cycle of the wheel!

Photo by Markus Spiske on Unsplash

Risks and Opportunity

Even though the wheel seems like a free money strategy, like everything else it works until it doesn’t and many risks come with opening these positions.

For example, when opening a CSP in a bear market the underlying blows past your strike and it keeps dipping. In this case, your contract would be worth a crap ton more than you sold it for, and to exit out of this trade you would have to pay out of pocket.

If you were to get assigned, even though you keep the premium from selling, the underlying has tanked so much that it outweighs the premium gained thus putting you at a significantly higher cost basis on your shares in perpetuity to the current share price.

The same goes for covered calls, when the stock rockets past your strike until expiration, capital gains will be capped compared to if you hadn’t sold the contract.

And to exit out the contract, you will have to BTC which will result in paying a significant amount out of pocket to cover the increase in the contract price.

Again, it works until it doesn’t, what will you do if you’re stuck in a bad situation?

Takeaways

Overall, even though trading the wheel is a very good introduction to trading options relatively safely and growing wealth over time, just like everything else crafting and refining is absolutely necessary to heighten long-term success.

I just want to reiterate that this article is just for a base understanding of what the wheel is and doesn’t go super in-depth about other Wheeling aspects.

In the future, I will be going over more introductions to different options strategies, and mechanics of trades so please stay tuned!!

THANKS FOR READING⚡️

I will be writing more about my Instagram experience, financial freedom, and whatever I find interesting. Please let me know in the comments on how I can improve my writing, and if you enjoyed please consider smashing that follow button!!

— Tristian Xu