Article
Understanding the Wheel Strategy: Complete Guide to Selling Cash-Secured Puts and Covered Calls
Learn the Wheel Strategy for options trading: sell cash-secured puts, get assigned shares, sell covered calls. Complete guide with examples, risks, and tips for consistent income.
Table of Contents
What is the Wheel Strategy?
The Wheel Strategy is a systematic options trading approach designed to generate consistent income while potentially acquiring stocks at a discount. It's particularly popular among income-focused traders and is sometimes called the "Triple Income Strategy."
The strategy gets its name from the cyclical nature of the process: you sell cash-secured puts, potentially get assigned shares, then sell covered calls on those shares. If your shares get called away, you start the wheel again. The beauty of this approach is that you collect premium at every step, whether or not you own the underlying stock.
How the Wheel Strategy Works
Step 1: Sell Cash-Secured Puts
You sell put options on a stock you'd be willing to own at a strike price below the current market price. You collect premium immediately. If the stock stays above the strike price at expiration, the put expires worthless and you keep the premium. If the stock falls below the strike, you're obligated to buy 100 shares per contract at the strike price.
Step 2: Assignment and Share Ownership
If assigned shares, your effective cost basis is reduced by the premium you collected. For example, if you sold a $50 strike put for $2 premium and got assigned, your net cost is $48 per share ($50 strike - $2 premium). Now you own the shares and can move to the next step.
Step 3: Sell Covered Calls
With shares in hand, you sell call options at a strike price above your cost basis. You collect more premium. If the stock stays below the strike, the call expires worthless and you keep the premium (and can sell another call). If the stock rises above the strike, your shares get called away at a profit, and you restart the wheel by selling puts again.
Advantages of the Wheel Strategy
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Consistent Premium Income
You collect premium at every stage of the cycle, regardless of market direction. This creates multiple income opportunities from the same capital.
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Lower Effective Cost Basis
When you get assigned shares, the premium you collected reduces your cost basis. This provides a margin of safety compared to simply buying shares outright.
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Defined Risk
Unlike naked options, your risk is clearly defined. Selling cash-secured puts means you have the capital to purchase the shares. Selling covered calls means you already own the shares.
Risks to Consider
While the Wheel Strategy is relatively conservative compared to other options strategies, it's not without risks:
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Assignment Risk During Crashes
If a stock crashes, you'll be assigned shares at a price well above the current market value. Your capital will be tied up in a losing position, and it may take time (or never) to recover.
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Opportunity Cost
If a stock rallies significantly, your shares will be called away at the strike price. You miss out on gains above the strike, though you still profit from the premium collected plus the difference between your cost basis and the strike.
Step-by-Step Implementation
Here's how to implement the Wheel Strategy:
- Choose a stock you'd be comfortable owning long-term. Look for stable companies with good fundamentals and moderate volatility (for better premium).
- Sell a cash-secured put at a strike price below the current market price (typically 5-15% out-of-the-money). Make sure you have enough cash to buy 100 shares per contract at the strike price.
- If the put expires worthless, repeat step 2. If assigned shares, proceed to step 4.
- Sell a covered call at a strike price above your cost basis (typically 5-15% out-of-the-money). Choose an expiration that balances premium collection with holding time.
- If the call expires worthless, repeat step 4. If shares are called away, return to step 2 and restart the wheel.
Real Example
Let's walk through a simple example with ABC stock trading at $100:
Sell a 30-day put at $95 strike for $2.50 premium. You collect $250 (100 shares × $2.50).
Stock drops to $92 at expiration. You're assigned 100 shares at $95. Your effective cost basis is $92.50 ($95 - $2.50 premium).
Sell a 30-day covered call at $100 strike for $2.00 premium. You collect $200.
If the stock reaches $100 and your shares are called away, you profit $750 + $200 = $950 in 60 days on $9,250 capital at risk (about 10.3% return in 2 months, or ~62% annualized). This doesn't include any dividends received.
Pro Tips for Success
- • Target 0.3-0.5 delta options for a balance between premium collection and probability of assignment.
- • Use 30-45 day expirations to maximize theta decay (time value erosion works in your favor).
- • Only wheel stocks you'd be happy to own for the long term. Don't chase high premiums on risky stocks.
- • Track your cost basis adjustments carefully. Tools like Njord Options can help automate this accounting.
Start Tracking Your Wheel Strategy Today
The Wheel Strategy is a proven method for generating consistent income through options trading. While it requires patience and discipline, it can produce attractive risk-adjusted returns. Proper tracking of your cost basis, premiums collected, and realized/unrealized P/L is essential for understanding your true performance.
Track your Wheel Strategy with precision.
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