Triple Income Approach with the Wheel Strategy

 

My friends knew me as somewhat of a trading whiz. Someone asked me for a strategy to generate personal income with little involvement of personal time. I told him to have a look at the Wheel Strategy.

What Is the Wheel Strategy?

The basic idea behind the Wheel Strategy is to generate regular income by using options (which are like contracts that give you the right to buy or sell stocks at a specific price). It’s called the “Wheel” because it involves a cycle of three steps that repeat. These steps are:

  1. Sell Cash-Secured Puts
  2. Buy the Stock (If You’re Assigned)
  3. Sell Covered Calls

Now, let's dive into each of these steps so you can see how the whole process works.

Step 1: Sell Cash-Secured Puts

This is where the strategy begins. Essentially, you sell a put option on a stock you’re willing to buy. A put option is a contract that gives someone else the right to sell you a stock at a specific price by a certain date. When you sell a put, you get paid a premium upfront (which is the amount someone will pay you for that option). You don’t own the stock yet, but you’re agreeing to buy it if the price falls below a certain level.

So, here’s the key: the “cash-secured” part means you need to have enough money in your account to actually buy the stock if the price drops below your strike price. This makes it a relatively low-risk strategy, because you are already prepared to buy the stock if needed.

For example, if you sell a put on stock IBM with a strike price of $100, and someone exercises their option to sell, you’ll have to buy the stock at $100. But here’s the cool part — you already got paid a premium (let’s say $2 per share), so your effective cost per share would be $98 ($100 strike price minus the $2 premium).

By selling the put, your aim is to make money via theta decay as long as the price remained neutral to bullish. When IBM price hit a key support price at let say $105, you'll sell a put option with strike price maybe 5%-10% below the current price or 0.3 delta (or lower) at the expiration date of maybe 30 - 45 days away - usually looking at the 3rd Friday of the next month.

Let's say on today on Jan 10, IBM stock price is at $105 and is at a major support level. You are expecting IBM stock price to remain at this level or higher by next month. So, you looked to sell a put option with expiry of Feb 21 with a strike price of $100. You received $200 upfront as premium. By Feb 21, as long as you are not assigned and if price remained 1 cent above $100, you get to keep the $200 all to yourself.

I prefer the selling the put option stage so I like to remain in this stage and keep selling put option for money. Selling the put option with a strike of 5%-10% below the current price or 0.3 delta is to provide a buffer for price to dip and rebound. As long as price remained above the strike, I don't need to worry about getting assigned the stock and can keep the premium, meaning the money is mine.

The 30-45 days date expiration is because theta decay speed up within these days. Any later and you don't gain as much from theta decay. The third Friday of each month is the monthly option expiry date and there's usually more activity and liquidity for options expiring on this date - better spread and pricing. But what about selling weekly puts with an expiration date less than 10 days away? I found not much difference between selling weekly or monthly. You make slightly more selling weekly puts but it'll take more effort on your part having sell option on a weekly basis. The aim here is also less time involved.

Step 2: Buy the Stock (If You’re Assigned)

If the stock price falls below your strike price, you’ll be “assigned” — meaning you’ll have to buy the stock at that strike price. This isn’t a bad thing though, because you were already comfortable with the idea of owning the stock at that price. In fact, you were hoping to buy it!

Let’s say IBM stock is trading at $98 and you sold a $100 put option. The stock falls to $98, and you’re assigned. You end up buying IBM for $100 per share, but you still got the $2 premium, so your net cost is $98. At this point, you now own the stock.

The next income of the wheel is from the capital appreciation of the stock you owned.

Step 3: Sell Covered Calls

Once you own the stock, it’s time to move to the next phase: selling covered calls. A covered call is when you sell the right to someone else to buy your stock at a certain price (strike price) within a set time frame. In exchange for selling this right, you get paid another premium upfront.

The key here is that you already own the stock, so you’re "covered." This strategy is all about collecting premiums while you hold onto the stock. If the stock goes up to the strike price and someone buys it from you, you sell the stock at that price — which means you’ll make a profit (the difference between your cost of buying the stock and the sale price). Plus, you keep the premium from selling the call.

Let’s say after you buy IBM for $98, you sell a call option with a strike price of $105. If the stock price rises to $105 or higher, the person who bought the option can exercise it, and you sell your stock at $105. You make a profit from the $98 you paid, plus the $2 premium you received from the call.

The key here is not to sell the call option with strike price below your cost basis. As long as you are not doing so, you are always aiming to sell for profit.

Rinse and Repeat

Once you’ve either sold your stock through a covered call or kept it (if the stock didn’t go up as much as you thought), you go back to selling cash-secured puts again, and the cycle continues. You can keep repeating the process, collecting premiums from both the puts and calls, and ideally, making steady income along the way.

The Benefits of the Wheel Strategy

  1. Consistent Income: By selling puts and calls, you’re getting paid premiums regularly. This can add up over time, and the best part is that you’re getting paid whether the stock goes up, down, or sideways — as long as you manage the strategy well.

  2. Lower Risk: Since you’re either selling puts on stocks you’re happy to own or selling calls on stocks you already own, your risk is much lower than trying to time the market or buy and sell without a plan.

  3. Flexibility: You can pick the stocks you want to trade options on, which gives you control over your investments. If you really like a company, you can use this strategy to gradually build your position.

Things to Keep in Mind

  • Patience is Key: This isn’t a get-rich-quick strategy. It’s about making steady, consistent income over time.
  • Choosing the Right Stocks: Make sure you’re picking stocks that you’re comfortable holding long-term if you get assigned. You don’t want to end up with a stock you don’t like just because it fell in price. The wheel strategy is a neutral to bullish strategy. So, always go with the stocks that's expected to go up in price.
  • Choose the Right Day: General advice is to sell put option on a red day, and sell call option on a green day. Just a general rule of thumb. It'll give better price for stock to move around.

Ramped It Up

  • Playing with Margin: This will take it out of the safer risk approach because it's no longer cash secured, but if you are confident that price will be higher by the option expiry date or the future, why not play with margin? Let say I have a $10,000 account, and a margin of $30,000, giving me around $40,000 of capital to play. IBM stock price is $105 currently. I am confident that it will be higher than $100 by next month. So, I sell not 1, but 3 put option with strike price of $100. I received 3 times the premium ($2 * 3 * 100 = $600). If price went lower than that by next month, I'll be assigned the stock and pay interest on the extra capital I used. After all, I am positive on the stock and capital appreciation will be more than enough to cover the interest on the margin I borrowed.
  • Selling ITM vs OTM: Currently, the recommended strategy is to sell out the money to give space for price to move around. Let say IBM stock price is at $105 at the moment. Selling the put option Out the Money meant selling it at a strike price below $105. Doing this will give me a lower premium, maybe $2. However, if I am very bullish on the stock and expect IBM to be higher than $110 by next month, I can sell an In the Money put option with strike price of $109. In this way, I am pocketing a higher premium of $7 for taking the risk of selling the option at a higher strike price.