The Wheel Strategy is a popular options trading strategy used by investors to generate income while also potentially buying a stock at a discount. The strategy involves selling puts on a stock you wouldn’t mind owning at a lower price and selling covered calls on a stock you already own to generate income.
However, the success of the strategy relies heavily on choosing the right stock , debt and liquidity, and valuation. Look for companies with a solid financial track record, sustainable competitive advantage, manageable debt levels, and reasonable valuation compared to peers. You can use a stock screener or stock picker to get ideas and save time.
When selecting stocks, aim for diversification across sectors and industries to spread out risk. Remember that stock prices can change over time, so you can apply the same logic to find new stocks for the Wheel Strategy in the future.
Determining the Right Strike Prices
The strike price of an option contract is the price at which the holder can buy or sell the underlying asset (in this case, the stock) if they choose to exercise the option. In the Wheel Strategy, you’ll be selling puts and covered calls, which means you’ll need to choose strike prices that make sense for your goals.
When selling puts, you’ll want to choose a strike price that is lower than the current market price of the stock. This gives you a buffer in case the stock price falls and the option is exercised. However, you should only sell puts on stocks you wouldn’t mind owning at the strike price.
For covered calls, you’ll want to choose a strike price that is higher than the current market price of the stock. This allows you to sell the option and potentially earn income while also potentially selling the stock at a profit. However, you should also consider the potential for missed gains if the stock price rises above the strike price and the option is exercised.
Strike prices can be adjusted to fit your goals and risk tolerance. For example, you could choose a strike price that is further out of the money (i.e., farther away from the current market price) for a higher potential profit but also higher risk, or choose a strike price that is closer to the current market price for a lower potential profit but lower risk.
In this article, we will explore how to implement the Wheel Strategy on three popular stocks: Oatly (OTLY), NIO, and Google (GOOG).
Oatly (OTLY)
Oatly is a Swedish food company that specializes in oat-based dairy alternatives, such as milk, cream, and yogurt. The company went public in May 2021, and its stock has been volatile ever since.
The first step in implementing the Wheel Strategy on OTLY is to identify the strike price that you are comfortable selling put options at. This strike price should be below the current market price of the stock, and should also be a price that you would be comfortable buying the stock at if the option is exercised.
For example, if the current market price of OTLY is $2.50, you might consider selling a put option with a strike price of $2.00. This means that if the stock price drops below $2.00, you would be obligated to buy the stock at that price.
Once you have sold the put option, you will collect the premium, which is the amount that the buyer pays you for the option. This premium represents the income that you will earn from the Wheel Strategy.
If the stock price remains above the strike price, the option will expire worthless, and you will keep the premium. You can then repeat the process by selling another put option with a new strike price.
If the stock price drops below the strike price, you will be obligated to buy the stock at that price. At this point, you can either hold the stock or sell a covered call option to generate additional income.
NIO
NIO is a Chinese electric vehicle manufacturer that has been gaining popularity in recent years. The company has been expanding its operations both domestically and internationally, and its stock price has been on the rise.
To implement the Wheel Strategy on NIO, you would start by identifying the strike price that you are comfortable selling put options at. This strike price should be below the current market price of the stock, and should also be a price that you would be comfortable buying the stock at if the option is exercised.
For example, if the current market price of NIO is $60, you might consider selling a put option with a strike price of $50. This means that if the stock price drops below $50, you would be obligated to buy the stock at that price.
Once you have sold the put option, you will collect the premium, which is the amount that the buyer pays you for the option. This premium represents the income that you will earn from the Wheel Strategy.
If the stock price remains above the strike price, the option will expire worthless, and you will keep the premium. You can then repeat the process by selling another put option with a new strike price.
GOOG
I picked GOOG for many reasons. A high-quality blue-chip company like Alphabet Inc. is well-suited for the wheel strategy for several reasons:
- Strong Financial Position: Blue-chip companies like Alphabet Inc. have a strong financial position, which reduces the risk of default. These companies generally have a solid balance sheet, ample liquidity, and strong cash flow, which provides them with the financial flexibility to invest in growth opportunities, pay dividends, and weather economic downturns.
- Stable Business Model: Blue-chip companies typically have a stable business model that generates consistent revenue and earnings growth. These companies are usually market leaders with a strong competitive advantage, which makes it less likely that their revenue and earnings will fluctuate significantly.
- Liquidity: Blue-chip companies generally have high liquidity, which makes it easier to enter and exit positions in the stock. This is important for implementing the wheel strategy because it involves selling options contracts, which can be illiquid for smaller or less well-known companies.
- Lower Risk: Investing in blue-chip companies is generally considered less risky than investing in smaller or less established companies. This is because blue-chip companies have a track record of success, a strong brand, and a large customer base, which reduces the risk of adverse events such as bankruptcy or market downturns.
Overall, a high-quality blue-chip company like Alphabet Inc. is well-suited for the wheel strategy because of its strong financial position, stable business model, liquidity, and lower risk profile. These factors make it easier to generate consistent income from selling options contracts while also mitigating risk.
In conclusion, the Wheel Strategy can be a profitable options trading strategy if you choose the right stocks and strike prices. Look for stocks with high liquidity and open interest, implied volatility in the range of 30 to 60, and solid long-term fundamentals. Choose strike prices that fit your goals and risk tolerance, and remember to diversify across sectors and industries. Keep in mind that strike prices may change based on market conditions, so always do your research and be prepared to adjust your strategy accordingly.