The wheel is a great options strategy for generating semi-passive income with a lower risk than many other strategies. What really shines in the options wheel is the consistency and scalability which can both benefit small and large accounts.
When trading options, always remember that the market will always be a game of chance. No matter how much time you put into research, the market will always remain unpredictable, and therefore it is important to only start with what you are willing to lose. Make a wise financial decision, and do not put all of your investing money into the wheel.
That being said, the amount of money required to start the wheel strategy is at least $2500. Having $2500 in your account ensures that you will be able to trade contracts on stocks or etfs which are above $20, which have significantly better risk-to-reward compared to penny stocks.
Step 1: Pick a Stock
The stock you pick for your wheel is extremely correlated to the performance of your account.
- Only pick a stock that your are bullish on, or think will rise in the long term.
- Only pick a stock that you can afford. Your account value must be 100x greater than the price of the stock.
Step 2: Sell a Cash Covered Put
Getting into the wording for all strategies can get confusing, so lets break it down into digestible chunks.
- Cash Secured = We have the money to buy the shares if assigned
- Selling a Put = We write a contract that someone else buys. When they buy the contract, we agree to buy 100 shares of a stock that we choose, in the case that the stock falls under a strike price that we determine. In return, the buyer of the contract pays us a “premium”, which is just money in return for the contract.
- Contract = A contract that is either bought or sold, each contract references to 100 shares.
Example — PINS FEB 05 ’21 67 Put (6.18)
In this put we agree to buy 100 shares of PINS if PINS drops down below $67. At the time of this example the price of PINS is now is $68.40, our contract will need $6700 of collateral, because the contract references 100 shares. The person who buys our put has until 5/2/21 for their contract, and after that, if it has not dropped below $67, then it will expire worthless and we can go into another put.
Here Where We Generate Income:
The person who bought our put paid us a premium, which in the above example is $6.18. In reality, that is $618 because our contract is for 100 shares. If the contract expires worthless, then we can keep the $618 as pure profit, and this is where we make our money. Theoretically, we can make this money forever, by repeating these steps of selling a contract, expiring worthless, keeping premium, and selling another one.
However, if we want to make the most money, we have to find a good balance between premium and strike price It is up to your risk tolerance to choose when you want to increase your premium or lower your strike price. Generally:
- A lower strike price will result in lower risk, but lower premium.
- A higher strike price will result in higher risk, but higher premium.
It is up to you to find that boundary, but generally, if you want an option to be worth your time, your premium should be at least 1% of the stocks price.Taking premiums lower is considered a waste of time, and will not generate significant profits. Finding your tolerance is important. In our in-depth guide: Selling Cash Secured Put Options: Get Paid To Buy Stocks At A Discount you will also learn the four possible outcomes.
Continue reading on the next page to learn more about step 3 of ‘The Wheel’ options income strategy.