Options strategies
The wheel strategy, explained
Selling puts until you’re assigned, then calls until the shares are sold: how one full cycle works with numbers, and where the strategy goes wrong.
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The wheel in one paragraph
The wheel strings two strategies together. You sell a cash-secured put on a stock you’re willing to own. If the put expires worthless, you keep the premium and sell another. If you’re assigned, you now own 100 shares, and you start selling covered calls on them. If the shares are called away, you’re back to cash, and the cycle can start again.
Its appeal is that every step collects a premium. Its weakness is that it still means owning a stock, with almost all of the downside of owning it and a cap on the upside. The premiums don’t change that; they only cushion it.
Step 1: sell a cash-secured put
You pick a stock and a strike below the current price, and keep the strike × 100 in cash for each contract. The put pays you a premium. As long as the stock stays above the strike at expiration, the put expires and you can repeat this step.
The usual advice, for good reason, is to only do this on a stock you’d be comfortable holding through a bad stretch. If you wouldn’t want to own it after a 20% fall, the wheel will eventually hand you exactly that situation.
Step 2: if assigned, you own the shares
If the stock is below the strike at expiration (or the put buyer exercises early), you buy 100 shares per contract at the strike. Your effective cost is the strike minus the premium you collected. The shares may be worth less than that on the day you get them.
From here you hold a stock position. Its value goes up and down with the stock every day, just like any other shares you own.
Step 3: sell covered calls on the shares
With the shares in hand, you sell calls against them, usually at a strike at or above your effective cost. Each call pays a premium. If the stock finishes below the strike, the call expires and you can sell another. If it finishes above, the shares are sold at the strike and the cycle is complete.
The tension is in the strike. A call well above your cost may pay little when the stock has fallen. A call below your cost pays more, but if it is exercised you sell the shares for less than you paid.
A full cycle, with numbers
Example
One trip around the wheel
All prices below come from the Black-Scholes model with implied volatility (IV) of 30%, a 4% interest rate and no dividend, before fees.
- Put. The stock trades at $100. You sell a 30-day $95 put for about $1.33 ($133) and set aside $9,500.
- Assignment. At expiration the stock is at $92. You buy 100 shares at $95. Your effective cost is $95 − $1.33 = $93.67 a share, while the shares are worth $92.
- Call. With the stock at $92, you sell a 30-day $95 call (at your purchase price, above your effective cost) for about $2.04 ($204).
Premiums collected so far: $133 + $204 = about $337. What happens next depends on where the stock is when the call expires.
| Stock when the call expires | What happens | Total result |
|---|---|---|
| Above $95 | Shares called away at $95 | +$337, about 3.5% of the $9,500 |
| $92 | Call expires; you still own the shares | +$37 (−$300 on paper on the shares, +$337 premiums) |
| $80 | Call expires; you still own the shares | −$1,163 (−$1,500 on paper on the shares, +$337 premiums) |
In the first row, a stock that went from $100 to $92 and back to $95 earned about 3.5% over roughly 60 days. In the last row, the premiums cover only a small part of a $15-a-share fall. If the stock had instead rallied to $110 by the second expiration, you’d still have sold at $95: the extra $1,500 would go to the call buyer.
When the wheel goes wrong
Risk
The stuck position
The hardest part of the wheel is a stock that falls well below your cost and stays there. Calls at or above your cost pay very little, and calls below it risk selling at a loss. You can end up holding shares for months, collecting small premiums against a large paper loss.
- Large drops: the premium is small compared with what a stock can lose in a bad quarter.
- Capped rallies: the strongest moves up are given away above the call strike, so the trades that would make up for the losses are cut short.
- Early assignment: puts and calls can be exercised before expiration, most often when they’re deep in the money or, for calls, just before an ex-dividend date.
- Concentration: $9,500 in one stock is a large position for many accounts. A wheel on one stock is a bet on that stock.
- Liquidity: every step is a trade at the bid or the ask. On options with wide bid-ask spreads or little open interest, those costs add up over a cycle and make it harder to close or roll a position at a fair price.
- Taxes and fees: frequent trades and share sales can create costs and taxable events that eat into small premiums.
Track the whole cycle, not each trade
Looked at one trade at a time, the wheel can seem to win almost every time: most options expire worthless and keep their premium. The honest measure is the whole cycle: every premium, every fee, and the gain or loss on the shares from assignment to sale. A run of small wins followed by one assignment on a falling stock can leave the cycle in a loss.
Writing down each cycle’s total, and comparing it with simply holding the stock or a broad-market fund over the same period, tells you whether the strategy is actually working for you. See Tracking your real returns for a simple way to do that.