What is the Wheel Options Trading Strategy?

The wheel options trading strategy is an options trading investing technique. It entails selling (writing) put options and, if assigned, covered call options on a certain underlying stock or investment. The strategy’s goal is to produce income while also potentially acquiring shares of the underlying stock at a lesser cost. This article is based on the book The Wheel Options Trading Strategy written by Markus Heitkoetter, an expert in trading options and stocks. The article aims to explain the basics of the wheel strategy and illustrate it with an example.

About the Book

The Wheel Options Trading Strategy is a great book to help you take your first steps in your trading journey. The book was published in 2021 with 157 pages and is available on Amazon for $22. It has received many positive reviews from readers. Based on the reviews, the book is in plain English and explains how you can earn an income from trading options. Since the explanations are in simple terms, even newbie traders can benefit from the book. There are also many examples and graphs to facilitate the comprehension of trading concepts. The size of the book is also an inviting factor for the audience as it does not take much time to study. Overall. It is hard to find a negative review of the book; most of the readers loved it and recommended it to others.

About the Author

Markus Heitkoetter, the self-made German multi-millionaire, is the writer of this book and three other best-sellers, namely The Complete Guide to Day Trading, PowerX Strategy, and The Simple Strategy. In addition, he shares his insights on trading on his YouTube channel with 103K subscribers. He came to the US with $30,000 and made his way through becoming an expert in trading stocks and options. He also founded the Rockwell Trading Institute in 2005 originally to share his knowledge with his family and friends. But now, the organization is hosting more than 300,000 traders from around the globe.

 

1.     The Basics of trading options in a capsule

Options trading is a financial strategy that involves the buying and selling of options contracts. An option is a contract that gives the holder the right, but not the obligation, to buy or sell an underlying asset (such as stocks, commodities, or indices) at a predetermined price (the strike price) within a specified time period (until the expiration date).

  • Types of Options:

There are two primary types of options: call options and put options. A call option gives the holder the right to buy an underlying asset at a specific strike price before the option’s expiration date. Call options are used when an investor anticipates that the price of the underlying asset will rise. If the price of the asset indeed increases, the call option holder can buy the asset at the lower strike price, resulting in a potential profit.

A put option gives the holder the right to sell an underlying asset at a specific strike price before the option’s expiration date. Put options are used when an investor expects the price of the underlying asset to fall. If the price of the asset decreases, the put option holder can sell the asset at a higher strike price, again potentially resulting in a profit.

  • Strike Price:

The strike price is the price at which the underlying asset can be bought or sold when exercising an option. It is a crucial factor that determines the potential profitability of the option.

  • Expiration Date:

Options have a limited lifespan. The expiration date is the date by which the option must be exercised, or it becomes worthless. Different options have different expiration dates, and traders need to consider the timing of their trades based on their expectations for the underlying asset’s movement.

  • Premium:

The premium is the price that the option buyer pays to the option seller for the rights conveyed by the option. It is essentially the cost of entering into the options contract. The premium is influenced by factors such as the underlying asset’s price, volatility, time until expiration, and market conditions.

  • In-the-Money (ITM), At-the-Money (ATM), and Out-of-the-Money (OTM):

An option’s relationship to the current price of the underlying asset determines its status. An option is in-the-money (ITM) if exercising it would result in a profit. In the case of a call option, it’s ITM if the underlying asset’s price is above the strike price. For a put option, it’s ITM if the underlying asset’s price is below the strike price. An option is at-the-money (ATM) when the strike price is approximately equal to the underlying asset’s current price. An option is out-of-the-money (OTM). If exercising, it would not be profitable. For a call option, it is OTM if the underlying asset’s price is below the strike price. For a put option, it is OTM if the underlying asset’s price is above the strike price.

  • Implied Volatility:

Implied volatility is a measure of how much the market expects the underlying asset’s price to fluctuate in the future. Higher implied volatility usually leads to higher option premiums as the potential for larger price movements increases.

  • Liquidity:

Liquidity refers to how easily an option can be bought or sold without significantly affecting its price. Highly liquid options have tight bid-ask spreads, making it easier for traders to enter and exit positions without incurring substantial costs.

  • Hedging and Speculation:

Options trading serves both speculative and hedging purposes. Hedging involves using options to protect an existing investment against potential losses. Speculators, on the other hand, use options to profit from price movements without necessarily owning the underlying asset.

  • Leverage:

Options trading provides leverage, meaning traders can control a larger position with a smaller upfront investment. While this leverage amplifies potential gains, it also magnifies potential losses, making risk management crucial.

  • Option Chains:

An option chain is a listing of all available options contracts for a particular underlying asset. It displays the various strike prices and expiration dates, along with their corresponding premiums and other key information.

 

2.     Trading strategies

Our focus in this article is the wheel options trading strategy, but before delving into the strategy, let’s warm up with more simple strategies. You can read more on trading strategies here.

  • Buy Call Options (Bullish Strategy):

This strategy is a fundamental approach in options trading when an investor believes that the price of an underlying asset will experience an upward trajectory. By purchasing call options, traders are essentially betting that the asset’s value will increase. Call options provide the trader with the right, but not the obligation, to buy the underlying asset at a predetermined price (strike price) before the option’s expiration date. If the asset’s price rises significantly above the strike price, the trader can exercise the call option, acquiring the asset at the lower strike price and then selling it at the higher market price. The difference between the two prices, minus the premium paid for the option, represents the potential profit.

  • Buy Put Options (Bearish Strategy):

In contrast to buying call options, this strategy is employed when a trader expects the price of the underlying asset to decline. By purchasing put options, traders speculate that the asset’s value will decrease. Put options grant the trader the right, but not the obligation, to sell the underlying asset at a predetermined strike price before the option’s expiration. If the asset’s price drops significantly below the strike price, the trader can exercise the put option, selling the asset at the higher strike price and then buying it back at the lower market price. The profit, in this case, also accounts for the initial premium paid for the option.

  • Covered Call (Income Generation):

A covered call is a conservative strategy used when a trader owns the underlying asset and is willing to potentially sell it at a specific price. By selling call options against the owned asset, the trader collects a premium. If the asset’s price remains below the strike price, the options expire worthless, and the trader retains the premium as income. This strategy is favored by investors seeking additional income from their holdings while maintaining the potential for capital appreciation.

  • Protective Put (Risk Management):

Protective put, also known as the “married put,” is a defensive strategy aimed at mitigating potential losses. When an investor is concerned about a decline in an asset’s price, they can buy put options. If the asset’s price falls, the put options’ value increases, compensating for the losses incurred on the owned asset. This approach provides downside protection, enabling traders to limit the extent of their losses.

  • Straddle (Volatility Strategy):

A straddle is utilized when traders anticipate significant price volatility in an asset but are uncertain about the direction of the movement. It involves purchasing both a call option and a put option with the same strike price and expiration. If the asset’s price experiences a substantial upward or downward movement, one of the options will likely yield significant gains, potentially offsetting the loss on the other option. This strategy capitalizes on the overall magnitude of the price change rather than its direction.

  • Strangle (Similar to Straddle):

Like the straddle, a strangle is employed when traders expect high volatility but are unsure about the specific direction of the price movement. However, in a strangle, traders purchase both a call option and a put option, but with different strike prices. This allows for a wider price range within which the strategy can be profitable. The goal is to capture gains from a substantial price move, regardless of whether it’s up or down.

  • Iron Condor (Range-Bound Strategy):

An iron condor is a neutral strategy designed for situations where traders believe that an asset’s price will remain within a specific range. It involves selling both a call spread (selling a call option at a lower strike price and buying a call option at a higher strike price) and a put spread (selling a put option at a lower strike price and buying a put option at a higher strike price). The trader profits from the premiums collected on the sold options as long as the asset’s price stays within the defined range.

  • Butterfly Spread (Limited Risk Strategy):

We use the butterfly spread when we anticipate anticipate minimal price movement in an asset. This strategy involves buying one call or put option, selling two options at a higher strike price, and then buying one more option at an even higher strike price. The combination of these options creates a profit zone within a specific range of prices. This strategy aims to achieve a balance between risk and reward while capitalizing on a narrow price range.

  • Vertical Spread (Directional Strategy):

A vertical spread is a directional strategy utilized when traders have a specific view of the asset’s price movement. In a bull call spread, a trader buys a lower strike call option and simultaneously sells a higher strike call option. This strategy benefits from a moderate upward price movement. Conversely, in a bear put spread, a trader buys a higher strike put option and sells a lower strike put option, capitalizing on a moderate downward price movement.

  • Long Calendar Spread (Time-Based Strategy):

The long calendar spread, also known as the time spread or horizontal spread, is employed to capitalize on the different time decay rates of options with different expiration dates. Traders simultaneously buy and sell options with the same strike price but different expiration dates. The strategy aims to benefit from the accelerated time decay of the shorter-term option while holding the longer-term option as a hedge. The hope is that the longer-term option’s value will increase more than the shorter-term option’s value will decrease.

 

The Wheel Options trading strategy

The wheel options trading strategy is based on the idea of getting paid while you are waiting to buy a stock, which is actually Warren Buffett’s strategy. Warren Buffett is using this strategy that you are about to learn. The most important thing is finding a stock for investment.

Setting the scene

Suppose you want to invest in XYZ stocks which have proven to have high intrinsic value, and you expect an uptrend in the stocks’ price direction. Is a technology company developing payment processors. Let’s say each share of XYZ is currently $130, and you intend to buy the stocks when the price retraces to $100. But you do not want to chase it; you want to want the stock to come back to you, and you never want to buy a stock at the high. It is always a good idea to buy your desired stocks when they are retracing. Therefore, you need to sell a put option (representing 100 XYZ shares) with an expiration date of (for example) 8/23/2023 and a strike price of $100. Also, the option’s premium is maybe $3.20. The option contract requires you to buy 100 XYZ shares when the price retraces to $100.

So, we are selling the 100 put with an expiration of August 20th for $3.20. Since options trade in 100 packs, this means that we are receiving $320. To do this, the broker requires you to have $1000 in your margin account. Without a margin account, you would need a $10,000 balance, so this makes a lot of sense to trade using a margin account.

Possible scenarios

With the above example in mind, let’s consider two possible scenarios. We want to sell the option for $320 when the contract expires. The first scenario is if the stock’s value goes above the strike price, which is $100. In this case, we still do not own the shares, and the profit and loss (P&L) from the stock is $0, but we do have $320 from the option contract. But for this, we do need a $1000-balanced margin account. We managed to earn this amount from the day we sold the put contract until it reached the expiration date 35 days later. Therefore, we made 35% in 35 days based on our margin. Without a margin account, we would have gained 3.5% in 35 days. Now we keep the money, and you can do the whole thing again at a slightly different strike price.

Another possible situation here is if the price goes below the strike price. What will happen then? Let’s say the XYZ stock value plummets to $90. But keep in mind that the presupposition is that the stock’s value increases in the long run despite the corrections and retracements. In this case, the profit and loss from the stock, since now you lost $10 times 100 shares because selling a put means the obligation to buy 100 shares of a stock at the strike price. This is where you would lose $1,000 on the stock, but you still have the amount earned by selling the contract ($320). Therefore, the profit mitigates your loss, and instead of losing $1000, you lose $650. Of course, this is an open P&L meaning the loss is realized only if you sell the stocks now (for $90 a share).

The implementation of the wheel options trading strategy

So far, we own the XYX stocks, but what can we do with them? This is actually where we use the wheel options trading strategy. Now that we own the stock, we can start selling calls meaning that we must sell 100 shares of the XYZ stock at the strike price. The XYZ stock value is currently $90 ($10 below the strike price), and we want to sell a call for $110 ($10 above the strike price), and we want to set the expiration date for 30 days. Also, the premium for the call contract is $5. Therefore, we can receive a $500 premium when the current price reaches the strike price. But what happens if the call contract expires worthless (if the stock’s value is below the strike price when it reaches maturity)?

Let’s say the stock’s value plummets further to $80, meaning that you would lose $20 times 100 shares, so your total loss on this stock amounts to $1,000. Then again, this is just the open P&L; you would only realize it if you actually sold the shares. Now, we gained a total of $820 ($500 on the option in addition to the $320 we received initially). So, we made $820 on the option in 65 days which is 82% of our margin account or 8.5% of the standard account.

Review of the scenarios

Let’s review the changes in the XYZ stock value so far. At first, the stock’s value was $120, and then it retraced to %100 (where we sold a put option). Next, the stock’s value supposedly plummeted to $90 and then to $80. Now, let’s say the stock’s price pulls back to $100. In this case, you virtually did not do anything on the stock, and yet you gained $820, which is your P&L since you are holding on to the shares. This is the beauty of the wheel options trading strategy that even when the stock’s price is going down, you can still make a profit.

What happens to trades in the wheel options trading strategy?

Now, let’s talk about the other two scenarios because there’s a possibility that the stock will go up. Let’s say the stock goes up to $105. What will happen then? We are making $5 times 100 shares, which adds up to $500 open P&L. Now the stock’s value is increasing again, which is exactly what we are after since we are bullish on the stock and we want to hold on to our shares. Now imagine the stock’s price increases to $120 ($10 above the strike price of our last call contract). Based on the call contract, we have to sell 100 shares when the stock’s value reaches the strike price. At this point, we sell all the shares we own, achieving $1000 ($10 times 100 shares). This adds up to $320 and the $500 we earned previously. Therefore, now we have a sum of $1,820 and no shares.

Now that we have sold all the XYZ shares, we can do the whole thing all over again. So, first, you would sell a put contract below the current stock price and earn a premium. Once you get assigned, you sell the call contract. That is the reason we call this strategy the wheel; it keeps turning as long as we want it to. This is a super powerful strategy that can make you a decent return. In this case, we made 182% percent of our margin account in 65.

Summary of the wheel options trading strategy

Let’s do a quick summary here. First of all, the wheel options trading strategy is a powerful strategy that can deliver 30% per year rather safely. And by safely, we say, “Hey, you can never know.” It might be that the stock keeps going down. Of course, then you have to keep doing it, despite the fact that the open P&L might show a larger loss, and you hope that eventually it goes up. Secondly, it is super important that you pick the right stock. And what is the right stock? The right stock is one that goes up in the longer run. You can do this almost forever and keep the premium, and you make more money when the stock goes up.

 

Wheel options trading strategy example

Now that we know how the wheel options trading strategy works let’s actually talk about a trade that we did with the “Wheel.” Now the wheel is an options trading strategy, where first we are selling puts to collect premium, and then once we get assigned the stocks, we’re selling calls to collect even more premium. The example is about one of our recent trades on Uber, where we got assigned the shares. Take a look at the screenshot below.

Selling the calls

When we are doing the wheel, it consists actually of three trades. The first is that we are selling puts, and the idea here is to collect premiums and to get assigned stocks at a discount, to buy stocks at a discount at a lower price than they are trading right now. Then once we have the shares, we are selling calls. So let us walk you through the process step by step to see how it works.

Selling the puts

The first trade that we did here and for the first trade is selling puts. So, let’s take a look at the very specific example here. Let’s take a look at the trade history, we are looking at year-to-date, and we want to know actually the transactions for the last 30 days for Uber. Based on the history, we sold seven on August 14th, 30 puts at $0.25, which yields $175 in one week. The idea here was that Uber was supposed to stay above 30, in which case, we would just collect the premium, and a week later, they expire, and we can move on and sell more calls. But Uber dipped below 30, and consequently, we got assigned the shares, and this is where we entered the second stage in the wheel options trading strategy.

Selling the shares

Since we sold seven puts, each representing 100 shares, we now have 700 Uber shares. But in this particular example, the broker assigned 400 shares to us. Also, because this is an open P&L, we do not realize the loss until we sell the shares and close the trade. And we have the $175 premium locked in. In the third stage of this strategy, we sell four calls for $52 each, which yields $208. So now we gained a total of $383 from the premium.

We went through the three stages of the wheel options trading strategies, and now we want to consider three possible scenarios for our trade. So, a week from now, we want to see what happens if Uber is below $30, what happens if Uber is between $30 and $31, and what happens if Uber is trading at $31. These are the three possible scenarios. Keep in mind that in either scenario, we can keep the $383 premium we gained from selling the puts and calls, and no one can take this away from us.

Three possible scenarios in the wheel options trading strategy

The first scenario is that Uber’s stock value decreases to $29 on the expiry date (August 28th). In this case, we would have an unrealized P&L on the assigned shares. But since we are not planning to close the trade at this point, it is of no importance.

The second scenario is that Uber’s stock value is $30.50 on the expiry date. This means that we have gained $200 (400share × $0.5) in addition to the $383 profit from selling the calls and the puts. This leaves us with an excellent $583 profit.

The third scenario (which is also the best scenario) is when Uber stock prices increase to more than $31. Since we sold 4 calls at the strike price of $31, it does not really matter if the price continues to go above $31. This means that we have to sell Uber again at $31. Therefore, if the price reaches $31 on the expiry date, we would make $400 because we bought each share for $30 and sold them again for $31. Added to the premium amount, we would now have gained $783 profit.

In short, if the price is below $30, we would sell calls again, and the wheel would continue. If it is between $30 and $31, we do the same and sell calls, and if it is above $31, we are being called away, so we are getting rid of the shares. And this means that right now, we would start selling puts again.

 

Final words

There are many approaches to trading options which you can apply based on your level of expertise in the options market. This article briefly described the basics of the options market and described ten options trading strategies as well as the wheel options trading strategy. We explained the wheel strategy based on Markus Heitkoetter’s insights. The wheel strategy follows three steps, namely, selling the puts, selling the calls, and selling the shares. The wheel options strategy can increase your revenues, but given the relative complexity, it works best for professional traders.