How Does The WHEEL Strategy Works?

I have mentioned the Wheel Strategy a few times in my previous articles and together with the LEAPS strategy, it is one of the two favourite strategies in options trading. In this article, I will share with you how this strategy works.

The Wheel Strategy is very easy to understand, it is basically made up of a series of selling PUT and CALL options. When you sell a PUT option contract, you basically agree to buy 100 units of the shares of Company ABC if the market share price is below the strike price (agreed contract price) on the date of expiration. In return, you collect a premium for selling a PUT option contract.

If you are confused about how a PUT options contract works, this simple analogy may just be able to help you:How PUT Option Works

Assuming your PUT option contract is being exercised and you have to buy 100 shares of Company ABC at the agreed (strike) price and you are a proud owner of 100 shares of Company ABC. What you can do now is to sell covered call on the 100 shares that you have. Selling a CALL option means you agree to sell 100 shares of Company ABC if the market share price rises above agreed (strike) price on expiration date. In return, you will get a premium for selling a CALL option contract.

This below analogy should help you understand CALL options better:How Call Option Works

Assuming your CALL option contract is exercised when the market share price rises above strike price on expiration date, you now sell away 100 shares of Company and get back the money from selling 100 shares of Company ABC. With that amount, you can sell another PUT contract and collect a premium. If the PUT option contract is not exercised this time round, you collect the premium without having to buy the shares of Company ABC. Thus, you can sell another PUT contract.

In essence, the Wheel Strategy starts when you sell a PUT contract for a period, say a month.

If exercised, you sell a CALL contract with the shares you own. If not exercised on expiry date, you continue to sell another PUT contract.

If you sell a CALL option contract and it gets exercised, then you can sell a PUT contract with the sales proceeds of selling your 100 shares. If your CALL option contract is not exercised, you continue to sell another CALL contract for another period, say a month.

The Wheel Strategy is a series of selling PUT and CALL option contract, depending on when the respective contract gets exercised or not.

Let’s use Apple stock as an example.

January 2022 (Sell PUT)

On 1st Jan 2022, the market price of Apple share is $160.

You start the Wheel Strategy by selling a PUT option contract, with details as follow:

Type of Option: PUTStrike price $165Expiration Date: 31 Jan 2022Premium Collected $16.50

On 31st Jan 2022, Apple stock closes at $166. You gain $1650 premium ($16.50 x 100) without requiring to buy 100 Apple Shares.

Feburary 2022 (Sell PUT)

On 1st Feb 2022, Apple share price is $166, you sell another PUT contract, with details as follow:

Type of Option: PUTStrike price $170Expiration Date: 28 Feb 2022Premium Collected $10

On 28 Feb 2022, Apple stock closes at $169. Thus, your PUT options contract is exercised and you will buy 100 shares of Apple at $170. The amount you need to pay is $17,000 ($170 x 100). But you will still get to keep the premium of $1000 ($10 x 100).

March 2022 (Sell CALL)

On 1 March 22, the share price of Apple stock is $169. As you now own 100 shares of Apple, you can sell covered call for your Apple shares, with details as follow:

Type of Option: CALLStrike price $168Expiration Date: 30 March 2022Premium Collected $8

On 30th March 2022, Apple stock closes at $166, which is below your strike price. You gain $800 ($8 x 100) premium without having to sell away your 100 Apple shares.

April 2022 (Sell CALL)

On 1 April 22, the share price of Apple stock is $166. As you still own 100 shares of Apple, you can sell covered CALL for your Apple shares, with details as follow:

Type of Option: CALLStrike price $160Expiration Date: 30 April 2022Premium Collected $12

On 30th April 2022, Apple stock closes at $163. You gain $1200 ($12 x 100) premium from selling a CALL option contract on Apple. However, as market close price is higher than your strike price for your CALL option contract, you will have to sell away your 100 shares at $16,000 ($160 x 100).

May 2022 (Sell PUT)

On 1st May 2022, the market price of Apple share is $163. With the $16,000 that you collected from selling your 100 shares previously, you can now sell another PUT option contract and collect another month of premium

Type of Option: PUTStrike price $160Expiration Date: 31 May 2022Premium Collected $14

If by month end, the option contract is exercised, you will sell CALL option in the following month. Else, you will continue to sell a PUT option contract. You take turn to spin the wheel and alternate between selling CALL and PUT option contracts.

I hope this explaination helps you understand this powerful strategy bettter. It can bring you consistent sideline income if you sell options on a stock with strong fundamentals, e.g. Apple. The price flucutation will not be drastic and you can earn good premium every month by either selling CALL or PUT options.

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