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.The wheel strategy is an excellent way to boost portfolio income, but it’s essential to choose the right underlying stocks. Click To Tweet
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:
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:
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.
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:
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:
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.
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:
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 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.