The Option Wheel Strategy Explained

Jesse Anderson

Published on October 10, 2023

Many investors turn to dividend stocks or bonds to generate income. But, if you’re willing to get a little more creative, stock options provide a compelling alternative. Covered calls and cash-secured puts can help you generate extra income from your existing long stock portfolio.

The Option Wheel strategy takes these strategies a step further by converting them into an income-generating machine. Using a rinse-and-repeat approach, you can consistently generate an income by writing covered calls and cash-secured puts on a rolling basis.

Let’s take a closer look at how it works and some tips to maximize income and minimize risk.

A Brief Review

Before diving into the Option Wheel strategy, it helps to understand how covered calls and cash-secured puts work along with some basic terminology.

Covered calls are an option strategy whereby you own a long position in a stock and write (sell) a call option on the same asset. In essence, you’re selling the right for another investor to buy your asset at a specified price (the strike price) within a certain timeframe (expiration date). In exchange, the buyer pays you a premium to establish the contract.

Cash-secured puts take a similar approach on the other side of the coin. In particular, the strategy involves selling the right for another investor to sell you an asset at a specified price (strike price) and within a certain timeframe (expiration date). Again, the buyer pays you a premium to establish the contract.

In both strategies, you keep the premium if the price never reaches the strike price. However, if the price surpasses the strike price, you may have to sell (covered calls) or buy (cash-secured puts) the asset at the agreed-upon price.

How the Option Wheel Works

The Option Wheel, also known as the triple income strategy or the covered call wheel strategy, involves selling options to generate income on a consistent, recurring basis.

There are three “spokes” in the wheel:

1. Sell a cash-secured put. The wheel begins by selling an out-of-the-money put option and earning the premium as income. If the stock price remains above the put’s strike price, the put option will expire worthless, allowing you to keep the entire premium. You can then sell another cash-secured put to continue the strategy. But, if the stock price falls below the strike price, you’ll likely have to buy the stock at the strike price. You will still keep the premium, but now you own the long stock position.
2. Sell a covered call. If you’ve been assigned the stock from the put option, your strategy wheel turns to the next step, which is selling a covered call. Like selling the put, you’ll collect a premium for selling the call option. If the stock’s price remains below the call’s strike price, the call will expire worthless and you get to keep the premium. The stock remains in your portfolio and you can sell another covered call against it. But, if the stock price rises above the strike price, you will have to sell the stock at the strike price.
3. Repeat. Once you’ve sold your shares, you’re back to having cash, which allows you to restart the wheel by selling another cash-secured put.

Tips for Using the Option Wheel

The Option Wheel is a relatively straightforward strategy if you’re familiar with covered calls and cash-secured puts, but there are a few best practices to keep in mind.

• Stock selection. You should only use the strategy on stocks you wouldn’t mind owning for the long term since there’s a good chance you’ll end up owning them during the process. As a result, you may want to screen for stocks based on a combination of fundamental criteria (e.g., price-earnings ratios or discounted cash flow analysis) and technical criteria (e.g., momentum or trends). You  can lose money if the stock goes down, but some of the losses are offset by the option income. This makes the strategy slightly less risky than outright stock ownership. 
• Income generation. The Option Wheel is primarily focused on generating income rather than capital appreciation. After all, covered calls inherently limit upside potential. Therefore, it’s essential to screen for cash-secured put and covered call opportunities that offer attractive annualized and if-called returns. You may also want to consider a stock’s dividend yield and ex-dividend dates to generate even more income.
• Risk. The Option Wheel involves a few risks. In addition to looking at fundamentals, it’s a good idea to look at an option’s downside protection (in the case of a covered call). The volatility of a stock is also heavily impacted by earnings, so it’s essential to understand when earnings are due out to manage risk.

Get Started with 0ptionDash

0ptionDash is one of the best option income screeners available for income-focused traders. With a focus on covered calls and cash-secured puts, you can find and sort specific opportunities based on everything from annualized returns to downside protection. And watchlists make it easy to save your favorite opportunities and follow up with them over time.

When screening for covered calls and cash-secured puts, you typically want to look for an out-of-the-money option with an expiration that’s 30 to 45 days out. The cash-secured put’s strike price should be a price that you’re comfortable owning the underlying stock, while the covered call’s strike price depends on expected volatility and the premium amount.

After finding some good candidates from an income standpoint, you can further screen based on a company’s fundamentals to ensure you’re comfortable owning it. The platform provides a quality score, value score, and trend score for each company. And you can see what top analysts think about the stock with individual and composite ratings.

0ptionDash also provides access to key dates impacting the stock price. For example, you can choose to exclude companies with upcoming earnings announcements or dividend payments since those events can heavily influence the stock price. That way, you’re not taking on unnecessary risk or missing anything in your due diligence.

And finally, advanced options traders can easily access and screen based on option Greeks, including theta and delta, as well as implied volatility. You can even see advanced metrics like the premium as a percentage of the strike price or moneyness, enabling you to execute advanced strategies using the platform’s automated screening capabilities.

After selecting the right opportunities, you can execute trades on your brokerage and add these positions to your watchlist on optionDash. That way, you can follow along with any new developments and ensure that you’re not missing anything important.

Final Words

The Option Wheel isn’t a “get-rich-quick” scheme. The most successful traders seek consistent income over time rather than chasing higher premiums and riskier options. You should pay just as much attention to risk (if not more) than you do to income or returns.

If you’re ready to get started with the Option Wheel, try optionDash to help streamline your research and watchlists. You can get started with covered call screening for free, while premium features include proprietary quality scores and cash-secured put screening capabilities.

If you’re not ready for the Option Wheel and would rather stick to covered calls, the Snider Investment Method might be a great fit for you. Our strategy takes the guesswork out of writing covered calls and helps you maximize portfolio income while managing risk.

Sign up for our free e-course today to learn more!