Wheel Strategy Explained Step by Step for Investors

Investing in the stock market may be intimidating because you are unsure of the place to start. A large number of traders seek ways to make a steady income without having to take undue risks. The wheel strategy is one of the most commonly used strategies by options traders. This way, investors can earn high premiums on options and also have the opportunity to purchase quality stocks at reduced prices. Here, we will discuss the steps of the wheel strategy in simple terms in this guide. You will know how it operates, how to install it, and the things that you really need to remember before using it.

Understanding The Wheel Strategy

It should be known before entering the step-by-step process what the wheel strategy is all about. One of the ways of earning a regular income through stock options is the use of the wheel options strategy. It is believed to be a neutral to bullish strategy and, as such, it works best in situations where you expect a stock to either remain constant or appreciate with time.

The idea is simple. You begin with the selling of cash-secured put options on a stock that you would not object to owning. When the option is assigned, you purchase the stock at the strike price. Then you sell covered calls on the shares you now own. When the shares are called away, then you once again go back to selling puts. This is a continuous process, like a wheel, and hence termed the wheel strategy.

Why Investors Like The Wheel Options Strategy

• It also lets you earn revenue periodically on the option premiums.
• It is not as risky as the other strategies because you only invest in stocks that you are comfortable with.
• It performs well in a lateral or slightly bullish market.
• It is not rigid because you can terminate the cycle at any moment.

Step One: Selling Cash Secured Puts

The first step in the wheel strategy is selling cash-secured puts. This means you sell a put option while keeping enough cash in your account to buy the stock if you are assigned.

How A Cash Secured Put Works

When you sell a put option, you are agreeing to buy a stock at a certain price, known as the strike price, if the buyer decides to exercise it. For taking on this obligation, you get paid a premium. The premium is yours to keep, no matter what happens.

For example, imagine a stock is trading at $50. You sell a put option with a strike price of $48 and receive $2 per share in premium. If the stock stays above $48, the option expires worthless, and you keep the $2 per share. If the stock falls below $48, you may be assigned and will buy the stock at $48 per share.

Choosing The Right Strike Price

The strike price you choose is important. You want to pick a level where you are comfortable buying the stock. Many traders choose a strike slightly below the current price to reduce risk.

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Step Two: Owning The Stock

If your cash-secured put gets assigned, you now own the stock. This is the next step in the options wheel strategy. Owning the stock sets you up for the next phase of the wheel, which is selling covered calls.

When assigned, you buy the stock at the strike price. This might be lower than the market price, which is good, but sometimes the stock could fall below that level. Either way, you now own the shares, and you still keep the premium you collected from selling the put.

Step Three: Selling Covered Calls

Once you own the stock, the next step is to sell covered calls. A covered call means selling a call option on the stock you already hold. When you sell a call option, you are giving someone else the right to buy your stock at the strike price. In return, you get paid a premium. If the stock stays below the strike price, the option expires, and you keep both the stock and the premium.

Most investors choose a strike price above the current stock price. This way, if the stock rises, they still make a profit when selling. If the stock stays flat or goes down, they simply keep the stock and the premium.

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Step Four: Repeating The Wheel

If your covered call gets assigned and your stock is sold, the wheel starts over. You go back to step one and sell cash-secured puts again. This cycle of selling puts, owning stock, and selling calls keeps rolling like a wheel.

Why The Wheel Keeps Working

The beauty of the wheel strategy is its repeatable process. You always earn premium income whether you are selling puts or calls. Over time, this can add up to consistent returns.

When To Stop The Wheel Strategy

You have the option to cease holding the stock or selling options at any point that you deem necessary. Others withdraw their investments when the market factors change or when they achieve their income objectives.

Benefits Of The Wheel Options Strategy

The wheel strategy is now famous due to the numerous benefits it offers to ordinary investors.

• Income From Premiums: You get premium revenue every time you sell an option. This provides a stable stream of cash flow, which is able to cross-subsidise other investments.
• Buying Stocks At A Discount: Through the sale of puts, you usually find yourself purchasing stocks that are lower than their current market value. This is a form of built-in discount.
• Lower Risk Compared To Other Strategies: Since you are buying stocks as an expansion of a position you already hold, the risk is not as high as high-leverage techniques such as naked options.

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Risks Of The Wheel Strategy Options

Although the wheel strategy is less risky than certain techniques, there are still risks to it.

Stock Price Declines

When the stock price drops drastically at the time you sell a put, you may have to repurchase at a higher price than the market. This may result in losses.

Opportunity Cost

When selling covered calls, your upside is minimal. Should the stock go skyrocketing, you could be left out of those huge profits.

Capital Requirement

In this strategy, there must be sufficient cash to purchase puts and sufficient shares to sell covered calls. Not every investor can possess the necessary capital.

Conclusion

The wheel options plan is a clever method by which investors can earn a stable income and remain connected with good stocks. Selling cash-secured puts, ownership of stock upon assignment, and covered calls all enable you to create a repeatable cycle that continues to generate results. Although this strategy does not help to remove all risks, it provides you with additional control of your investments and may be effective under various market conditions. The wheel strategy may be a useful part of your investment career, though, provided you move slowly, take your risks, and concentrate on good companies.