The options wheel strategy is a trading approach that involves selling options to generate income, often with the goal of acquiring or holding a particular stock. To perform the wheel strategy for a living, it’s best to understand how it actually works in depth. This is a method that is particularly suited for investors who are comfortable with the idea of owning stock at a potentially discounted price. Here’s a step-by-step guide on how to perform this actively.
10 Steps Of The Wheel Strategy For A Living
1. Select a Stock
Choose a stock that you wouldn’t mind owning for the long term. Look for stocks with strong fundamentals, stable financials, and ones you believe have growth potential.
Don’t just select the first one actually liked. Take the time to look at the historical chart, the money health of the company, and the future plans for the growth aspect.
2. Fundamental Analysis
Conduct thorough fundamental analysis to ensure the stock is fundamentally sound and aligns with your investment goals.
Fundamentals include things like understanding the company’s business model and competitive position, how it generates revenue and if this is sustainable, the ROE (return on equity), the ROA (return on assets), the Debt Ratio, the management team’s experience and record, the entire industry the company is in, even how current interest rates and inflation impacts the company in question.
One can decide on one stock or another after some basic research involving factors like these mentioned.
3. Sell Cash-Secured Puts
Once you’ve identified a stock, sell cash-secured put options with a strike price below the current market price. This obligates you to buy the stock if the price drops below the strike price by expiration.
This strategy is effective when you have a bullish or neutral outlook on a stock. You are essentially betting that the stock price will remain above the put option’s strike price by expiration.
Finally, selling cash-secured puts requires having sufficient cash in your account to cover the potential purchase of the underlying stock if the option is exercised. This helps mitigate risk, as you only sell puts on stocks you are willing and financially able to purchase.
4. Generate Premium Income
By selling the put option, you receive a premium, which becomes your income. This money is yours to keep, regardless of whether the option is exercised. This action provides an immediate reliable income stream.
Two ways of money generation by selling the puts involve both the premium and the lower stock price purchase, should the low strike price be crossed. The lower buy price means potential future gain through stock value enhancement.
Over a year and over time, these gains can really add up to a big pile of money indeed.
5. Wait for Expiration
Let the options expire. If the stock price remains above the put option’s strike price, you keep the premium as profit, and the process can be repeated. Just go on to scout and buy another cash-secured put to generate another round of income.
6. Assigned the Stock
If the stock price falls below the strike price, you might be assigned the stock. Be prepared to purchase the stock at the strike price using the cash set aside when selling the put.
It’s called “cash-secured” for a reason. The brokerage demands money be in the actual account to cover the potential purchase of the company stock. Only then can a cash-secured put be sold, and only after of course applying to actually sell options whatsoever, with the same brokerage.
Keep in mind that each transaction incurs transaction costs, such as commissions and fees, which will be deducted from your account.
After the assignment, you become the owner of the purchased stock. You can choose to hold the stock in your portfolio, sell it immediately, or implement additional strategies, such as covered calls, to generate further income.
And selling a covered call after ownership is part of the wheel strategy that goes round and round.
If the covered call strike is breached and the stock must be sold off, one could repeat the process all again by beginning with selling another cash-secured put contract.
7. Covered Calls
Once you own the stock, you can sell covered call options against it. Choose a strike price above the current stock price and collect the premium.
This is the inverse of the cash-secured put option contract. Now ownership is part of the equation.
With the covered call, if the value of stock stays below your selected strike price, you keep both the stock and the premium involved.
8. Repeat the Cycle
Just continue on repeating the cycle as chosen. To make the wheel strategy for a living happen, one just needs to make the wheel turn over time.
Understanding both puts and calls and the basics involved goes a long way toward success. And this method happens to be one of the easiest stock market ways for making a consistent income over time.
9. Risk Management
Always have a risk management strategy in place. Don’t invest more than you can afford to lose, and consider using stop-loss orders to mitigate against catastrophe. Stop-loss orders may not be chosen for example with strong and viable companies. But if you chose lesser companies, mitigating against too steep of loss may be considered as part of the equation, especially after owning the stock.
10. Continuous Monitoring
Monitoring may be quite passive, maybe looking in on the stock and options once or twice a week. A few seconds or minutes may be all that’s needed.
Keep an eye on market conditions, company news, and any factors that may impact your chosen stock. Be ready to adjust your strategy if needed.
Important Considerations
Diversification: Do avoid putting all your money into some single stock. Try to diversify investments to spread risk around.
Implied Volatility: Higher volatility often results in higher options premiums, providing more income potential but also increased risk.
Market Conditions: Adjust your strategy based on overall market conditions, economic indicators, and changes in interest rates.
Remember that options trading involves risks, and it’s important to thoroughly understand the strategy and associated risks before implementing it. Consider consulting with a financial advisor or doing further research to tailor the strategy to your specific financial situation and risk tolerance.
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