My favorite option trading strategy is the wheel strategy because it is safer and easier than other strategies. In this chapter, I will demonstrate how to use this strategy in five simple steps to generate a consistent income of $5,000 or more every month. In fact, I personally made over $100,000 last month thanks to the wheel strategy. Therefore, it is crucial to read this chapter carefully and take notes to create a secure passive income stream.
The wheel strategy is a process for entering stocks at the right price while maintaining control over risk and return. It is particularly appealing for those in their 30s, 40s, or older who require safe and consistent income. With the wheel strategy, you can generate a steady income of $5,000 or more per month. For example, my student Dennis has earned $6,500 per month for many consecutive months using only the wheel strategy. The most significant advantage of this strategy is that assignment and management are minimal.
How To Do The Wheel Strategy (5-simple steps)
Here are the five easy steps to follow:
- Choose a stock that you would not mind owning. It can be any stock that you believe is a good long-term investment to start running the wheel strategy.
- Sell a put option on that stock at a strike price below the current market price. By doing so, you agree to buy the stock at the strike price if it falls to that level. You will receive a premium payment upfront for taking on this obligation. I suggest selecting a put option to sell at around 30 delta. While it is essential to balance collecting high income, it is also crucial not to get assigned right away. In other words, it is better to collect 2% per week for five weeks before getting assigned than being assigned right away. However, there is nothing wrong with assignment since the goal is to own the stock.
- If the stock price remains above the strike price, the put option will expire worthless, and you will keep the premium payment. You can then repeat this process by selling another put option at a lower strike price.
- If the stock price falls below the strike price, and the put option is exercised, you will be required to buy the stock at the strike price. However, since you received a premium payment upfront, your effective purchase price is lower than the strike price. You can hold onto the stock as a long-term investment or sell a covered call option to generate additional income.
- Repeat the process by selling another put option at a lower strike price or selling a covered call option on the stock that you own.
Picking Strikes For The Wheel
It is essential to understand why it is necessary to maximize your return while minimizing your risk. For instance, picking a delta to sell the put between 20 and 30 is ideal since it helps to collect the premium without being assigned stock right away. Going below 20 might limit your returns while going for a 40 delta means you will get assigned almost as often as a coin flip. Therefore, the best strike to choose is one below the current stock price with a delta that is between 20 and 40.
Wheel Gameplan
Additionally, being ready and able to take the stock is part of the plan, but being assigned is not the goal. The plan is to make 2% a week and keep repeating that for as long as possible. Selling short or cash-secured puts (CSPs) indicates that you have the cash/margin to buy the stock if it is assigned. Therefore, it is vital to be aware of any upcoming earnings reports or other events.
When To Do the Wheel Strategy
The wheel strategy is not only a safe and consistent way to generate income, but it is also a versatile trading strategy. Once you understand the basic mechanics of the wheel strategy, you can apply it to various market conditions and stocks. Let’s take a closer look at how you can use the wheel strategy in different scenarios.
- Bullish MarketIn a bullish market, you can use the wheel strategy to capitalize on the upward trend of a stock. For example, let’s say you want to invest in Apple Inc. (AAPL), which is currently trading at $150 per share. You can sell a put option at a strike price of $140, which is 7% below the current market price. If the stock price remains above $140, you will keep the premium payment, and you can sell another put option at a lower strike price. If the stock price falls below $140, and the put option is exercised, you will be required to buy the stock at $140. However, since you received a premium payment upfront, your effective purchase price is $137. This means you bought the stock at a discount and can hold onto it as a long-term investment or sell a covered call option to generate additional income.
- Bearish MarketIn a bearish market, you can use the wheel strategy to buy stocks at a discount and generate income from selling covered call options. For example, let’s say you want to invest in XYZ stock, which is currently trading at $60 per share. You can sell a put option at a strike price of $50, which is 17% below the market price. If the stock price remains above $50, you will keep the premium payment, and you can sell another put option at a lower strike price. If the stock price falls below $50, and the put option is exercised, you will be required to buy the stock at $50. However, since you received a premium payment upfront, your effective purchase price is $47. This means you bought the stock at a discount and can sell a covered call option at a higher strike price to generate additional income.
- volatile marketIn a volatile market, you can use the wheel strategy to profit from the price swings of a stock. For example, let’s say you want to invest in XYZ stock, which is known for its high volatility. You can sell a put option at a strike price of say $200 for example, which is 10% below the market price. If the stock price remains above $200, you will keep the premium payment, and you can sell another put option at a lower strike price. If the stock price falls below $200, and the put option is exercised, you will be required to buy the stock at $200. However, since you received a premium payment upfront, your effective purchase price is $170. This means you bought the stock at a discount and can sell a covered call option at a higher strike price to generate additional income.
Wheel Strategy Conclusion
In conclusion, the wheel strategy is a versatile and effective option trading technique that can help traders generate consistent income and manage risk in their portfolios. By using a combination of covered calls and cash-secured puts, traders can potentially profit in both bullish and bearish market conditions while limiting their downside risk. I refer to the wheel as the cashflow machine because regardless if you are selling puts to start the wheel or selling covered calls to exit the wheel, you are producing cash flow.