My Quest to Build a Million Dollar a Year Income Stream with Options Trading

The Options Wheel Strategy

Looking for a low-risk strategy for collecting premiums while selling options? Then the wheel strategy is the one for you. It involves selling cash-secured puts and covered calls in a cyclical manner to generate profit. 

So, how does this work?

Lets see the wheel in motion

Sell a Cash-Covered Put

We start the wheel by selling a cash-covered put on a stock we believe to be mildly bullish.  Ideally the stock would go up and premium is collected without assignment. However, if it is assigned you will have 100 shares of stock at a pretty good price.

So what do you do when the stock goes up and the Put expires? This is perfect, because you keep the premium from the Put that expires worthless, and you sell a new one collecting the premium again. You can continue repeating this process of selling a cash-secured Put, letting it expire worthless, and then selling another one indefinitely.

Sell Covered-Call

What if the stock price drops, and your Put gets assigned, you now own 100 shares of the stock? So the next step that you do if this happens is to sell a covered Call.  Ideally, the strike price for the Call should be above the price the shares got assigned for. This way you can profit from the sale of the stock itself, in addition to the option premium you collect by selling the Call.

If the price never rises above the strike price, your Call will expire worthless. You keep the premium from that option, and sell a new Covered Call collecting a new premium. You can continue repeating this process of selling a Covered Call, letting it expire worthless, and then selling a new one indefinitely.

A Cyclical cycle

As the diagram illustrates, you start the process by selling a cash-covered put. If the stock price goes down you get assigned 100 shares at a lower price.  Then you sell a covered call, and if the stock prices goes up you collect the premium while selling the shares for a higher price and make a profit. 

Fantastic! You make your premium and a profit!  ……And then you repeat this cycle all over again!

When to Pause the Wheel

As mentioned in the beginning, this strategy is great for when you’re mildly bullish on a stock, or even if it’s just going sideways. But what if you think the market has peaked? It’s when you think the stock price has gotten too high that you might want to pause on selling a new Put. This is because if the price falls, you could end up owning the stock at a fairly high price just as it’s entering a downward cycle.

However, you can protect yourself when the stock price starts getting too high by buying a Put at a lower strike price than the one you sold. This creates a spread that prevents you from getting stuck with the stock at too high of a price if it takes a major dive. With a spread, your maximum loss is only the price difference between the Put you sold and the Put you bought.

If the stock price drops too far after the Put assignment, you may want to wait before selling the Call. If you do sell a Call, don’t open it for a strike price so low you lose money on the sale of the stock. However, each call that you sell that expires worthless effectively reduces your cost basis on the stock. So factor that in when setting your next strike price.

Build your cash, sell another Put

As you repeat this cycle over and over, you’re going to build up a nice pile of cash. Once you have enough, you can start a new cycle by selling a cash-secured Put on a different stock, or even on the same stock you’re already trading on. With two options going at any given time you will be doubling the amount of income you’re bringing in!

As you can imagine, at double the pace, it won’t take long before you have enough cash to start a third cycle going. And then a fourth, and a fifth. This is a very low-risk way to scale your options trading while a market is going up or even just going sideways.

Not without Risk

The Wheel Strategy is a great way to establish a passive options income, but it does come with some risk. And the main risk is the stock itself.

This strategy is reliant on trading options on a high-quality, stable stock that isn’t at risk for a big fall. If you choose a risker stock, you must remember that you are going to be in a long stock position once the Put is assigned. If that company gets into trouble, and the stock craters, you could lose big.

As always, choose your stocks wisely, and be patient.

What do you think about this strategy? Have you used the Wheel Strategy before?

Leave a comment below on your experience with the wheel strategy. Also be sure to subscribe so you never miss a blog post!

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