How to Find Stocks for the Wheel Strategy

Jesse Anderson

Published on July 7, 2023

Many investors turn to dividend stocks or bonds to generate income from their portfolio, but options can provide an additional boost. You can earn an upfront premium above and beyond dividends using covered calls and cash-secured puts. And the wheel strategy offers a systematic way to combine these strategies to maximize income.

In this article, you’ll learn what stocks are ideal for the wheel strategy and how to screen for them using tools like optionDash.

What is the Wheel Strategy?

The wheel strategy is a systematic method for selling options that combine covered calls and cash-secured puts. The goal is to generate consistent income from option premiums, and if you’re assigned the stock, potentially benefit from dividends and any price appreciation.

There are three main stages:

1. Sell a Cash-secured Put – You start by selling a put option on a stock you wouldn’t mind owning at a price below its current market price. And you receive the option premium upfront.
2. If Assigned, Sell a Covered Call – If the stock price drops below your cash-secured put’s strike price, you must buy the shares (since you sold a put option). When this occurs, you sell a covered call option on the shares, earning another option premium
3. If Assigned, Start Over – If the stock price rises above the call option’s strike price, your shares will get called away. You are then back to the starting point where you can sell another cash-secured put, and the “wheel” keeps on turning.

Wheel Strategy Example

Suppose you come across a company, ABC Corp., that you’re comfortable owning over the long term and want to execute the wheel strategy. Currently, the stock is trading for $50 per share.

Here’s how it might play out:

1. You sell one out-of-the-money put option with a strike price of $45 that expires in 30 days. You receive a $2 premium.
2. The stock price falls to $43 on the expiration date. Since you sold a put option, you must purchase the stock for $45 per share. 
3. You sell one out-of-the-money covered call on your newly acquired shares with a strike price of $50, expiring in 30 days. You receive a $1.50 premium.
4. The stock price rises to $52 on the expiration date, so your shares get assigned, and you have to sell for $50.

In the end, you generated $3.50 in total premiums and $5 in capital gains when you bought the shares at  the put strike price of $45 and sold at $50. So, your total profit was $8.50. Over the same timeframe, the shares went from $50 to $52, earning just $2.00.  This is almost an ideal scenario for the wheel strategy, but it helps explain the opportunity with covered calls and cash-secured puts. 

What Stocks Are Ideal?

The wheel strategy works best with stable, large-cap, dividend-paying stocks you’d be comfortable owning for the long term. After all, the most significant risk involved with the strategy is the stock price moving sharply lower when you own the stock.

Some characteristics to look for include:

• Balanced Volatility – High volatility can lead to more frequent assignments and increased risk, while very low volatility can result in lower premiums. So, a balance is ideal.
• Dividend Payers – Dividend-paying stocks offer additional income while you are holding shares, making them attractive to many investors looking to generate extra cash.
• Strong Fundamentals – You need to be comfortable owning the shares if assigned. So, it pays to look for companies with strong balance sheets, stable earnings, and solid market positions.
• Sufficient Liquidity – The options market for the stock should be highly-liquid since wide bid-ask spreads can eat into profits.

How to Screen for Opportunities

Option screeners make it easy to identify opportunities based on quantitative characteristics. While the results of a screen are only a starting point, they can significantly reduce the amount of time it takes to whittle down the best opportunities.

Consider the following screening criteria:

• Size and Sector – Large-cap stocks in utilities and consumer staples sectors are less volatile and more stable.
• Implied Volatility – Stocks with moderate implied volatility (e.g., expectations of future volatility) could be a safer bet.
• Dividend Yield – Dividend-paying companies can add income when you’re in a long stock position and demonstrate financial health and responsibility from the company.
• Valuation Metrics – Companies with low debt-to-equity ratios, reasonable P/E ratios, and stable EPS growth could have less risk than growth stocks or turnaround opportunities.
• Technical Analysis – Low volatility and an upward trend are generally preferable to minimize risks.

optionDash is one of the best screeners for the wheel strategy, offering covered call and cash-secured put screening capabilities.

The platform makes it easy to screen and sort opportunities based on dividend yields, downside protection, and annualized returns. You can also spot-check fundamentals at-a-glance with a quality, trend, and value score, making it easier to find the right fit.

You can also access idea lists (e.g., Dividend Aristocrats and others), create your own watchlists, save screening criteria, and access our proprietary scoring system.

Risk Factors

The wheel strategy involves many of the same risks as conventional covered calls and cash-secured puts. However, these risks may vary depending on where in the wheel you are. For example, opportunity cost risks only exist at the covered call stage.

The most significant risks include:

• Stock price decline – A drop in the underlying stock price could leave you with shares worth significantly less than you paid for them, resulting in potentially substantial losses.
• Opportunity costs – If the stock price rises sharply after selling a covered call, you will miss out on the additional gains since you’re obligated to sell your shares at the strike price.
• Assignment risk – Selling options involve the risk of being assigned, leading to unexpected buying or selling of shares, which can impact your overall portfolio.
• Liquidity risk – If options are not very liquid, opening or closing positions at desirable prices can be challenging, leading to losses.

In addition to these risks, option income is typically treated as a short-term capital gain, which translates to higher tax rates than long-term capital gains – particularly if you fall into a high tax bracket.

The Bottom Line

The wheel strategy can be an excellent way to generate income, but it’s not a magic bullet and comes with risks. The best way to mitigate these risks is to choose the right stocks and adequately manage the positions over time to avoid problems. The combination of an efficient option screener and a robust management strategy can help.

Get started with optionDash today! Or, signup for Snider Advisors’ free e-courses to learn how to manage covered call positions.