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An In-depth Guide to the Theta Gang Wheel Strategy

Not long ago this blog featured different trading strategies that utilize the Theta Gang mindset of selling options for premium. One strategy in particular that is becoming much more mainstream in the options trading world is “The Wheel Strategy”. This strategy utilizes selling options to collect weekly premiums while keeping a very low risk profile.

The premise behind the strategy is as follows.

  1. Sell an OTM put option on a stock you intend to hold for the long-term.
  2. If the put expires OTM, collect the premium and restart the process.
  3. If the put expires ITM, get assigned the shares.
  4. Once you have been assigned the shares you sell covered calls against the stock which lowers your cost basis until the shares get called away.

In theory if you execute this strategy perfectly every time it would be impossible to close your position at a loss. Remember, it’s only a realized loss when you sell the position!

Note: This is a guest contribution from Swaggy from SwaggyStocks, and a great one. If you’re looking for a common sense approach for trading options, then theta capturing strategies like the wheel can be very profitable over time.

Why is this strategy less risky than other option plays?

This strategy is much less risky than buying calls outright or over-leveraging yourself by selling multiple spreads on a stock. When you run the wheel you aren’t using leverage and are aiming to make profits as time, or “Theta”, goes by.

If your initial position on the PUT option goes against you and expires ITM you turn your strategy into a glorified “buy-and-hold” and yet again continue to sell premium against your shares.

This AI trading bot from SwaggyStocks does a great job at showing how the strategy works in real-time. The bot automatically runs the wheel on a handful of stocks and you can see the win rate is extremely high.

What are the downsides and the upsides to The Wheel Strategy?

Like most investing strategies, you generally align a higher reward with a higher risk profile and a lower reward with a strategy that takes on less risk. The Wheel Strategy involves minimal risk while providing medium-sized returns.

Having said that, some of the downsides to the strategy are actually the limited upside you would receive while in a bull market.

If you were to sell a cash-secured-put with a maximum of 3% gain, if the market shoots up 10% during that time you are still limited to your 3% gain.

The Wheel Strategy out-performs in markets that are slightly up or slightly down, and flat. The strategy under-performs in big bull or big bear markets.

In a big bull market, you miss out on the lost opportunity of gains. In a big bear market, you get assigned the shares and are forced into a buy and hold strategy. However, even in this absolute worst case scenario, being assigned shares from selling OTM puts will always be at a lower cost basis than if you were owning the shares outright.

A few ways you can modify risks while running the wheel strategy.

1. Open a covered put by buying a put at a strike price much lower than the strike price you sold the put. Essentially this opens a spread and protects you should the stock see un-expected downside that blows past your short put.

One thing to remember is that purchasing the protective put on every position ends up cutting into your profits over time. Even if it’s only a few dollars, multiply that by hundreds of positions and you are losing a small chunk of profit.

2. If the put you sold becomes contested you can roll the option down in strike price and out in expiration for a credit. Doing this will usually enable you to receive a credit from rolling as long as the stock price is still OTM from the put option you sold.

Rolling the option works best when it is still out-the-money and has lots of intrinsic value. If your short put is already in-the-money and begins to have an intrinsic value it might be too late to receive a good value from rolling it out.

Any method that will “protect” your position will also cut into profits, so if your initial return was 3%, rolling down and out might yield you a net of only 1%; or sometimes just get you to break-even. However, doing so will still avoid a loss and protect your capital.

3. You can change the delta and expiration you sell the put at to modify how much risk you are willing to take. A lower delta will be less risky, while a higher delta being closer to at-the-money will have more risk attached.

Similarly, weekly expirations will be more risky than selling 4-6 weeks (which is somewhat of the theta sweet spot) out as it doesn’t allow much time to recover should the position go against you.

Best stocks to run the wheel on?

The Wheel strategy works best on stocks with higher implied volatility (IV). Higher IV provide better premiums for selling options and usually lower returns for those purchasing the option.

A stock with low volatility and a low ‘expected move’ might return only 0.5% weekly while a stock with higher IV could potentially return 2-5% per week!

As a general rule and in today’s market I like to look for stocks that have options with an IV greater than 50 or 60%.

Where can I find stocks with high Implied Volatility (IV)?

Stocks with higher IV tend to have larger swings in price and thus are more volatile. Your trading app or broker that you trade on will provide you with the implied volatility of the option chains for any stock that has options available.

SwaggyStocks’ FD Rankr is a tool I use that shows a list of popular stocks and their average implied volatility. You can sort by next earnings date, implied volatility, and by stock price to find a stock that’s right for your account size. Selecting a ticker will display a chart that provides you with the historical IV for the ticker.

Using this you can see if IV has spiked and might be a good time to sell or if IV for the ticker has been going down. Here’s a sample image of AAPL Implied Volatility: the gold line is AAPL stock price and the blue line is its historical IV.

This is a great visual that showcases when a stock price “crashes” or goes down, the IV will increase. Vice-versa if the stock price starts to stabilize or slowly increase, the IV will begin to melt away.