The wheel strategy is a popular option strategy that aims to achieve a profit with the combination of Cash Secured Puts and Covered calls achieve an additional return on your existing share portfolio. You can find out exactly how this works in this blog post by guest author Alexander Eichhorn.
Wheel strategy procedure
The wheel strategy consists of two option strategies Cash Secured Put and Covered Call. The wheel strategy is structured as follows:
- Optimal stock selection: The first step is stock selection. The main prerequisite for the wheel strategy is the desire to buy a share at a certain price. As an option usually relates to 100 shares, there should be sufficient cash in the account.
Example: A 50 put option is an investment of USD 5,000 (100 shares * 50 strike price). In addition, the stock selection should not be too speculative, as insolvency of the company will lead to large losses despite the use of the wheel strategy. In principle, the strategy works with all optionable underlyings, including ETFs.
Important: Only select stocks for the wheel strategy that are also suitable for your long-term portfolio!
- Trading a cash-secured put: The aim of a cash-secured put is to acquire shares at a more favorable entry price by selling an out-of-the-money put option. The writer receives an option premium for this put option, so that he is remunerated for the waiting period for the more favorable entry price. If the put option expires worthless at the end of the term, the process can be repeated and a new put option can be sold. However, if the option is in the money at the end of the term, 100 shares are booked. Step 3 now follows with the wheel strategy.
Tip: There are a few things to bear in mind with cash-secured puts from a tax perspective! Tax consultant Frank Konewka has published an article on this in the blog on Trading-Steuerberatung.de: to the blog post
- Trading a covered call: The investor now holds 100 shares in the securities account and would like to option them further. He therefore sells a short call on the existing shares. This short call is hedged by the shareholding of 100 shares and is referred to as a "covered call". If the call is out of the money at expiry and the option expires worthless, the investor can issue a new covered call and collect premiums again. However, if the option expires in the money, the shares are derecognized at the strike price and step 4 follows. However, the investor may still keep the call premium.
- Repetition of the "wheel": The investor no longer holds any shares as they have been booked out through a covered call. He has gone through the "wheel" once and can start again at step 1 and select new shares for the wheel strategy.
Wheel strategy with index ETFs
In recent years, the product segment of ETFs experienced very strong growth. In the course of this success, the US stock exchanges have also offered ETF options for some ETFs in order to further strengthen the trading opportunities for ETFs. As a rule, an ETF option (like a share) has a contract value of 100 shares, i.e. 1 ETF option relates to 100 ETF shares. Trading the wheel strategy is therefore also possible with ETFs!
Below we list the most popular index ETFs that are also liquidly tradable with options:
- S&P 500 ETFs: SPY, IVV, VOO
- Nasdaq ETF: QQQ
- Russel-2000 ETF: IWM
- Dow Jones ETF: DIA
- MSCI World Index ETF: URTH
- DAX-ETF: DAX (ETF, very illiquid)
Many sector/industry ETFs are also suitable for this purpose:
- Technology ETF: XLK
- Healthcare ETF: XLV
- Biotechnology ETF: IBB
- Cyclical consumer goods ETF: XLY
- Communication Technology ETF: XLC
- Financial sector ETF: XLF
- Energy ETF: XLE
- Industry ETF: XLI
- Non-cyclical consumer goods ETF: XLP
- REIT ETFs: XLRE, VNQ
Tip: On etfdb.com many other ETFs can be filtered.
Advantages of the wheel strategy:
The wheel strategy offers several advantages. Here are some of the most important advantages:
- Passive income: The strategy aims to generate passive income from selling options without having to trade very often.
- Potentially higher returns: Compared to just buying and selling stocks, the wheel strategy can potentially offer higher returns because you can generate additional income from selling options.
- Flexibility: If the share price falls unexpectedly during the term of the option, you can decide whether to keep or sell the share in order to minimize the loss.
- Long-term stability: The Wheel strategy is particularly well suited to stocks that are stable over the long term, show continuous growth and therefore offer high potential for long-term gains.
In summary, the Wheel strategy offers a way to generate passive income while having limited risk, making it an attractive options trading strategy for long-term investors.
Disadvantages of the wheel strategy:
Although the wheel strategy offers many advantages, there are also some disadvantages to consider. Here are some of the main disadvantages:
- Limited profit potential: A covered call limits possible price gains through the call option.
- Restriction to certain stocks: The wheel strategy is best suited to stocks that are stable over the long term and show continuous growth. It is therefore not suitable for all types of shares.
- Risks in the event of a sharp fall in the share price: Although the risk is limited, a sharp fall in the share price during the term of the option can lead to a loss if you have to buy the share at a higher price in order to fulfill the option.
- Limited scope for action: If you own shares on which you sell options, you are restricted to a certain extent and cannot trade as flexibly as with other options trading strategies.
- Complexity: The Wheel strategy requires a basic understanding of options and can be difficult for beginners to understand due to the complexity of the strategy.
In summary, there are some disadvantages to the wheel strategy, particularly in terms of limited profit potential and risks in the event of a sharp fall in price. It is important to understand these drawbacks and take appropriate risk management measures.
Conclusion on the wheel strategy
The wheel strategy can be very successful in the long term, especially if it is implemented with shares of companies that are stable in the long term and show continuous growth. However, it requires a certain level of experience and knowledge in options trading as well as a solid understanding of how the market works.
