Today I want to discuss a trading strategy that I use to get into my stock positions. This strategy has become famous throughout the internet as the Wheel Strategy or the Wheel of Fortune strategy.
A few factors to consider before entering the wheel strategy:
- I’m doing this on a stock I don’t mind owning long term. This is why I use this strategy on the dividend stocks I like. Because I don’t mind owning these forever.
- I’m okay if the stock ends up shooting skywards and I miss out on opportunity cost. There are many stocks that could end up skyrocketing and then FOMO enters the equation.
- You need to have enough cash to purchase 100 shares the stock. This may be impractical for smaller accounts. In which case, a cheaper dividend stock could be a candidate for the wheel strategy.
With these in mind, I then execute the wheel strategy.
- Sell a Cash-Secured Put on a stock you don’t mind owning. Earn premium.
- If you don’t get assigned, sell another Cash-Secured Put. Repeat the process to earn premium until you get assigned.
- Once assigned, turn around and sell covered calls at the same strike or higher to earn premium on the stock you own. Repeat the process until your shares get called away.
- Once the shares are called away, repeat the process back at the beginning.
The Wheel Strategy
Wheel Strategy Step 1: Sell a Cash-Secured Put
To demonstrate the logistics of the Wheel strategy, I will use AAPL stock.
The wheel strategy starts off by selling a cash-secured put at a strike price below the current price of the stock. Right now AAPL is trading at $133.11.
Looking at the current options chain, I notice that the 130 strike that expires in 30 days is currently trading between $3.55 and $3.70 per contract. If I sold a cash-secured put at the 130 strike, I could earn $3.55 in premium. Additionally, $130 is a price I’m comfortable buying AAPL stock at.
So I place an order to sell 1 put at the 130 strike for $3.55. The total I earn is $354.35 after commissions.
One way to look at this is that AAPL is currently paying $0.205 per share in dividends. With 100 shares of AAPL, that would equate to $20.50 in dividends every 3 months. However this requires owning 100 shares of AAPL.
With this cash secured put, I’m immediately earning $354.35 in 30 days. Based on this dividend perspective alone, the wheel strategy already outperforms simply owning the stock.
If AAPL drops below $130 by expiration, then I get to buy the stock at $130. Since it’s trading at $133 right now, I’ll be entering into AAPL at a better price. From that point on, I’ll continue to own AAPL and continue collecting dividends as well as capital gains from its growth over time.
If AAPL stays above $130 by expiration, then after 30 days, I can sell another cash secured put to make more money depending on where AAPL is trading.
Wheel Strategy Step 2: Sell a Covered Call
Normally my version of the wheel strategy stops here because I want to hold onto these stocks for dividends.
However, there may come a time when I want to exit my positions. Possibly reasons include the changing environment, the business changes, or a dividend gets cut.
So the next step is to exit the stock and complete the Wheel strategy cycle. And to do this you would sell a covered call.
Using AAPL again to demonstrate, let’s assume that I currently own 100 shares of AAPL and I want to get rid of it because some bad news came out.
I look at the AAPL options chain again and notice that the calls at the 134 strike expiring in 30 days are around $4.45 to $4.60.
Since AAPL is currently trading at $133, I figured that the $134 strike is close enough and has a high probability of me getting my shares called away. Also, the $445 is a nice credit and also outperforms the current AAPL dividend of $20.50 per 3 months.
I sell the AAPL 134 call.
This earns me a total of $444.35 after commissions.
If AAPL goes above $134 by expiration, then my shares will get called away and I’ll be paid $13,400 for my 100 shares of AAPL. I would receive $13,844.35 if we include the covered calls. My total profit for the trade would be the $444.35 from the covered call plus the profit from the stock gain of $100 for a total of $544.35.
If AAPL stays below $134 by expiration, then I keep the $444.35 I made from selling the covered call. Then I can repeat the covered call process next month for additional cash until my shares finally get called away.
Once the shares get called away, the Wheel strategy is complete and we can start back at step 1.
6 thoughts on “The Wheel Strategy – Enhancing Your Portfolio”
Thank you, Nero. I know stocks, but options were a grey area to me, probably because I thought I needed a lot of knowledge about greeks.
I would like to also ask you about your priority of funds allocations to IRA vs 401k vs Roth vs keeping them in a traditional brokerage account. I see you prioritize Roth over 401k? How come? I thought that it is beneficial to set funds to pre-rax accounts to lower your tax rate now as during retirement the tax brackets are supposed to be lower. (?)
Hi Sam. I usually maximize my Roth at the beginning of the year while the 401k takes a while to max out because I have to wait for them to take it off of each paycheck. I turned 401k contributions off earlier this year since I was buying a house but I will be re-contributing again soon and try to max it out.
Thank you, Nero. I thought that I might be missing something that may be the pre-tax IRA allocations may not be beneficial over, for example, Roth.
Nero, I don’t think your intent is bad, but your article is completely bogus. The fact that your math is so poor, it worries me that you’re not completely broke by now, and you have this finance blog giving people advice!? First of all, you write:
“One way to look at this is that AAPL is currently paying $0.205 per share in dividends. With 100 shares of AAPL, that would equate to $205 in dividends every 3 months. However this requires owning 100 shares of AAPL.”
Can you read that to yourself again and double check your math? Let’s try this: $0.205 x 100 = ? How has no one else caught this? This is hugely misleading.
Second misleading statement:
“If AAPL goes above $134 by expiration, then my shares will get called away and I’ll be paid $13,400 for my 100 shares of AAPL. My total profit would be $13,844.35 if we include the covered calls.”
Your total profit?!? Do you know what profit means? Look that up, because I guarantee your account did not go up by $13,844.35.
Your readers are going to get slaughtered.
Good eye David, I went back and double checked my work and made the changes.
@David: There are better and kinder ways to make a comment. The article is not bogus. Yes – Nero is just human and made a couple of mathematical errors and has graciously corrected them. But the strategy still stands right? Always ok to provide feedback but there is no good reason to be rude about it.