A Continuous Income Cycle
You’ve mastered the fundamentals of selling Covered Calls on stocks you own and selling Cash-Secured Puts to acquire stocks at a discount. Now, it’s time to combine these two powerful strategies into a single, seamless system for continuous income generation: The Wheel Strategy.
The Wheel is not a new or complex trade; it is a disciplined, systematic process for repeatedly earning option premium from a handful of high-quality stocks. Think of it as a complete business plan for your investments, turning your portfolio into a machine that cycles between generating income from cash and generating income from stocks.
Who Is This Strategy For?
The Wheel strategy is the perfect next step for a patient, long-term investor who:
- Is comfortable with both Covered Calls and Cash-Secured Puts.
- Has identified a small list of high-quality companies they would be happy to own.
- Is focused on generating consistent income and growing their portfolio.
- Understands that this is a long-term strategy that performs best with stable, reliable stocks.
This strategy is not for a trader looking for fast action or for someone who is not comfortable holding a stock through potential market downturns.
What is the Wheel Options Strategy: A Simple Four-Step Loop
Wheel Strategy Step by Step Example
The beauty of The Wheel is its simplicity. It’s a continuous cycle that logically flows from one strategy to the next.
Step 1: Sell a Cash-Secured Put You begin the process with cash. You select a high-quality stock you want to own and sell a cash-secured put, collecting a premium. Your goal is either to keep the premium if the stock stays above your strike price or to be “assigned” the shares at your desired price.
Step 2: Get Assigned and Acquire the Stock If the stock price drops below your strike price by expiration, you are assigned the shares. This is a planned and welcome outcome. You use your secured cash to buy 100 shares of the company at an effective cost basis that is lower than your strike price, thanks to the premium you collected.
Step 3: Sell a Covered Call Immediately after acquiring the 100 shares, you transition to the next phase of the strategy. You now sell a covered call against your newly acquired stock, collecting another premium. You are now being paid to hold the stock you just bought.
Step 4: Get Called Away or Repeat
- If the stock is “called away” (sold at the strike price), the cycle is complete. You have successfully profited from the put premium, the call premium, and potentially a capital gain on the stock. You are now back to a full cash position and can return to Step 1 to begin the cycle again.
- If the covered call expires worthless, you simply keep the premium and return to Step 3 to sell another covered call, continuing to generate income from your stock holding.
A Walk-Through Example of The Wheel in Action
Let’s follow one complete cycle using our fictional “Blue Chip Inc.” (BCI) stock.
Situation: You have at least $10,000 in cash and want to run the Wheel strategy on BCI.
Phase 1: The Cash-Secured Put
- The Trade: BCI is trading at $102. You sell one 30-day put option with a $100 strike price and collect a $1.50 ($150) premium. Your broker secures $10,000 of your cash.
- The Outcome: At expiration, BCI has fallen to $99. You are assigned. Your broker uses your $10,000 to buy 100 shares of BCI at $100 per share.
- Result: You now own 100 shares of BCI. Your effective cost basis is $98.50 per share ($100 strike – $1.50 premium).
Phase 2: The Covered Call
- The Trade: With BCI stock now in your account, you immediately sell one 30-day call option with a $102.50 strike price and collect a $2.00 ($200) premium.
- The Outcome: At expiration, BCI has risen to $104. Your call is in-the-money, and your shares are called away. Your 100 shares are automatically sold at the agreed-upon strike price of $102.50.
- Result: The cycle is complete. Let’s tally the total profit:
- Put Premium: +$150
- Call Premium: +$200
- Stock Capital Gain: ($102.50 sale price – $98.50 cost basis) x 100 shares = +$400
- Total Profit for the Cycle: $750
You are now back to holding cash (more than you started with) and are ready to sell a new put on BCI or another quality stock to start the Wheel all over again.
The Most Important Rule: Stock Selection is Everything
The Wheel is a stock-centric strategy. Its long-term success depends entirely on the quality and stability of the underlying companies you choose. This strategy is not a way to make a bad company profitable.
What are the best stocks for the wheel strategy for income to add to your IRA.
Ideal candidates for the Wheel strategy are:
- Financially Sound, Blue-Chip Companies: You must be willing to become a long-term shareholder if the stock price drops.
- Stocks with Lower Volatility: While high volatility can mean higher premiums, it also means higher risk of the stock price plummeting far below your purchase price. The goal is steady income, not wild price swings.
- Highly Liquid: As always, ensure both the stock and its options are heavily traded to keep your transaction costs low.
The Risks You Must Understand
The primary risk of the Wheel strategy is the same as owning stock: if the company’s stock price falls significantly, you will have an unrealized loss on your position. While the premiums you collect will lower your cost basis and cushion the loss, they will not prevent it in a steep decline.
This is why you must think of yourself as a long-term value investor first and an options seller second. If you are assigned a stock at $100 and it falls to $70, you must have the conviction to hold the stock and continue selling covered calls (likely at much lower strike prices) while you wait for it to recover.
Is the wheel strategy good for retirement? You will have to decide based on your own risk tolerances and management.
Congratulations! You now understand how to combine two simple strategies into a powerful, systematic engine for generating long-term income in your retirement account.