What Is the Wheel Strategy in Options Trading?

Fundamental Option Concepts

An option is a financial contract giving the buyer the right, but not the obligation, to buy or sell an underlying asset at a predetermined price (the strike price) by a specified expiration date. The buyer pays a non-refundable premium to the seller for this right. This premium compensates the seller for the potential obligation and is credited to their brokerage account.

A put option gives the holder the right to sell 100 shares of an underlying asset at the strike price by the expiration date. The seller of a put option assumes the obligation to buy 100 shares at the strike price if the option is exercised. This means the seller must be prepared to purchase the shares, regardless of the current market price, if the option is in-the-money at expiration.

A call option grants its holder the right to buy 100 shares of an underlying asset at the strike price by the expiration date. The seller of a call option assumes the obligation to sell 100 shares at the strike price if the option is exercised. This means the seller must deliver the shares at the strike price, even if the market price is significantly higher.

The cash-secured put strategy involves selling a put option while holding sufficient cash in a brokerage account to purchase the underlying stock if the option is exercised. This collateral, 100 times the strike price per contract, ensures the investor can fulfill their obligation to buy the shares at the strike price. Premiums received are generally treated as short-term capital gains if the option expires worthless or is closed out within one year.

A covered call strategy involves selling a call option against shares of stock already owned. Because the investor possesses 100 shares of the underlying stock for each contract, the call option is “covered,” meaning no additional margin is required. This ownership provides the necessary collateral to fulfill the obligation to sell the shares if the option is exercised. Premiums collected are generally treated as short-term capital gains if the option position is closed or expires within one year.

The Wheel Strategy Process

The wheel strategy begins by selling out-of-the-money (OTM) cash-secured put options on a chosen stock. The objective is to collect premium income from these options. The investor selects options with an expiration date from one week to a few months, aiming for the option to expire worthless.

If the stock price remains above the strike price through expiration, the put option expires worthless. The investor retains the full premium collected from the initial sale, which is recorded as a short-term capital gain. With the option expired, the investor can repeat the first step, selling another cash-secured put option to continue generating premium income without acquiring shares.

If the stock price falls below the strike price by expiration, the put option will likely be assigned, obligating the investor to purchase 100 shares per contract at the strike price. This means the cash held as collateral for the put is used to acquire the shares. The cost basis of these shares is the strike price minus the per-share premium received, forming the basis for future capital gain or loss calculations.

After acquiring shares through put assignment, the strategy transitions to selling covered call options against these shares. The investor sells an out-of-the-money (OTM) covered call, selecting a strike price above their cost basis in the stock and an expiration date in the near term. The goal is to collect additional premium while holding the stock, aiming for the call option to expire worthless.

If the stock price remains below the call option strike price through expiration, the covered call expires worthless. The investor retains the premium collected from the call sale, which is also treated as a short-term capital gain, and continues to own the stock. The investor can then sell another covered call option against their shares, continuing to generate income from premiums.

If the stock price rises above the call option strike price by expiration, the covered call option will likely be assigned. This obligates the investor to sell their 100 shares per contract at the call option’s strike price. The sale results in a capital gain or loss, calculated based on the difference between the sale price (strike price) and the adjusted cost basis of the shares.

After shares are sold due to call option assignment, the investor receives the proceeds from the stock sale, plus any premiums collected from previous call sales. This completes one full cycle of the wheel strategy, as the investor no longer holds the stock. The investor can then use these funds to initiate a new cycle by returning to the first step: selling cash-secured put options on the same or a different stock, restarting premium generation.

Practical Considerations for Execution

Underlying asset selection for the wheel strategy focuses on stocks that exhibit specific characteristics. Investors choose companies with a consistent trading history and stable price movements, avoiding highly volatile or thinly traded securities. Such assets are preferred because their predictable behavior simplifies option position management and reduces the likelihood of undesirable assignments.

Capital management is key to executing the wheel strategy. When selling cash-secured put options, the investor must allocate funds equal to the potential purchase price of the shares (strike price multiplied by 100 per contract) as collateral. These funds remain earmarked until the option expires worthless or is assigned, then used to acquire the stock.

If the put option is assigned, allocated cash converts into shares. The capital is then tied up as equity. When covered calls are sold, no additional capital is held as collateral for the option, as existing stock ownership serves that purpose.

Premiums collected from selling both put and call options are deposited into the investor’s account, increasing the cash balance. These premiums represent income generated by the strategy, which can be reinvested or withdrawn. The cycle of capital allocation from cash to stock and back to cash, with continuous premium inflow, defines the strategy’s financial mechanics.

Strike price and expiration date selection influences the wheel strategy’s outcomes. Choosing an out-of-the-money (OTM) strike price for put options means selecting a price below the current market value, resulting in a lower premium but reduced probability of assignment. Conversely, a strike price closer to the current market price yields a higher premium but increases the likelihood of assignment.

For covered call options, an OTM strike price above the acquired stock’s cost basis means the investor aims to sell the stock for a profit if assigned, while collecting premium. Shorter expiration dates, such as weekly or bi-weekly options, offer lower premiums but allow for more frequent option selling cycles. Longer expiration dates, like monthly options, provide higher premiums but tie up capital longer and reduce premium collection frequency.