The Wheel Strategy for Beginners: Step-by-Step Guide to Consistent Options Income

The Wheel is a beginner friendly options selling strategy that uses the option SELLING side of the transaction in order to generate predictable gains and returns. Depending on the stock (also known as underlying) that you choose, you can sell options on stocks that you like holding, putting them to work for you while you wait!

Options can be sold daily, weekly, monthly or even yearly! So you can put as much or as little effort into this as you want while potentially earning from 0.5% to 5% a week in gains! If you do the math, that is 25% - 250% annualized returns!

How the Wheel Works in Simple Terms

There are only 4 types of options transactions at the most basic level: Buying or Selling Calls or Puts. That's it! Everything else you read about with options are just combinations of those, sometimes using different expiration dates, but they are still the same 4 transactions.

The Wheel generally focuses on Selling Calls or Puts though sometimes we incorporate the other 2 transactions that we will discuss in other articles, specifically buying back your options early.

For the purpose of this article, we're going to focus on the most basic form of the wheel which is selling calls also known as "Covered Calls" and selling puts, usually described as "Cash Secured Puts" though there are other forms we won't talk about here and are not recommended (i.e. selling "naked" calls & puts).

The basic idea is we want to sell options on a stock. We sell Cash Secured Puts to ENTER a position, meaning as a way to buy the stock and we sell Covered Calls to EXIT a position, meaning as a way to sell the stock. Rinse and repeat-o.

Every time you sell the option, you gain what is known as a “premium” which is a fancy way of saying cash money. Option buyers (the people buying the options you’re selling) pay you a premium to take the bet that the stock will go above or below the strike price you sold your option at. That’s it!

Why "The Wheel" is Popular Among Beginner Traders

Selling options using The Wheel is great for beginners because it teaches the safer side of options in a way that is hard to lose money. The biggest risk is probably clicking on "buy" instead of "sell" when on the option trading screen.

Key Benefits of The Wheel Strategy for Beginners

The most important benefit to beginners is the limited risk in learning the basics of options trading. While most brokerages seem to encourage BUYING options to start, that unfortunately does not benefit the average retail investor (you and me). It benefits institutional investors as they like to play the role of the “house” as much as possible, to guarantee their returns when selling options to retail investors.

Using this strategy, you will learn BOTH sides of the transaction over time, because you will see the statistical advantage you have as the seller in the form of cold hard cash!

Risks of The Wheel Strategy in Trading & How to Manage Them

I’ve created 5 Golden Rules that I believe everyone using the wheel strategy should consider!

1. Sell options on stocks you are happy to own.

2. Never panic, especially during after hour trading.

3. Stocks don't only go up, or only go down; have patience.

4. Don't over extend, max trade size of 10%, max position size of 20%.

5. Always take profit!

   
   

What is the Wheel Options Strategy?

Glossary for "The Wheel Strategy" Terms:

Before we get into the steps, let’s make sure we cover some definitions of the terms we are about to use:

• Option Buyer - the person buying the option contract who has the right, but not the obligation to purchase shares if the option finishes in the money

• Option Seller - the person selling the option contract who has the obligation to buy or sell shares if the option finishes in the money

• Contract - this is the agreement between an option seller and buyer to handle the transfer of money & shares as contract conditions are met

• Strike - this refers to the strike price of an option, which is the price that you are choosing to sell an option at that will result in either buying the stock or selling it if the strike price is exceeded. This is also referred to as an option being “in the money” as seen here:

  • In the case of selling a put with a strike price of $50, you are obligated to buy 100 shares x the number of contracts at $50 when the price reaches $50 or below.

  • In the case of selling a call with a strike price of $50, you are obligated to sell 100 shares x the number of contracts at $50 when the price reaches $50 or above.

  • Out of the money - when an option contract does not reach the chosen strike price.

• Brokerage - the company that facilitates buying and selling of options. E.g. Robinhood, Vanguard, Fidelity, IBKR, Schwab, Webull, etc.

• Assigned Shares - this happens when selling puts reaches your strike price and you are required to buy the shares at the strike price.

• Called Away Shares - this occurs when selling calls reaches your strike price and you are required to sell your shares at the strike price.

  
  

Step 1: Selling Cash Secured Puts (CSPs) & Buying the Stock at a Discount

If you don’t already own a stock with at least 100 shares, you have two paths to choose: either buy at least 100 shares of a stock (or a multiple of 100), or sell Cash Secured Puts aka CSPs in order to enter into a stock position.

A CSP means that you have enough cash set aside (secured) to buy the stock in the case that the stock price is below your strike price by the time of expiration. Let’s look at an example of this type of transaction. I like a lot of stocks, but we’ll use NVDA (nVidia) as our ticker of choice for this example.

Currently NVDA is trading at around $170-175 at the time of writing this article. If you are happy to own it around that price, why not make some money while you try to buy it? Doing this has a couple of benefits, one of which is downside protection should the price drop further than you expect. But regardless, this can be a more efficient way to buy shares of a stock that you like rather than just clicking “buy at market price” in your brokerage. 

In the case of NVDA, maybe we really like the price at around $170 and the option chain at close of this Friday shows that we could sell that option for $3 per share. Since an option contract always has 100 shares, we could try to sell 1 contract for $300 in premium received. We will receive that premium whether or not the price is below $170 and if the price is below $170 aka “in the money” then we will be assigned the shares and buy them at $170.

But that means our actual cost basis of the stock after the transaction is all said and done is actually $167 per share! The difference being the $3 of premium we received per share. That is paid to us in cash! And that cash can be used to do anything, including buying more shares of the stock! This also requires that you have enough cash set aside in your account to buy the stock at the strike price, which in this case would be $17,000.

Step 2: Selling Covered Calls

Now let’s assume you eventually were assigned shares or already owned them. Well, let’s put them to work! Now it’s time to choose a strike and sell covered calls on them. If we stick with NVDA that we bought for $170 in the prior section, let’s sell covered calls and make some more money!

Since we bought the shares at $170, I want to make money from selling the option, but also give myself some room for the shares to appreciate. I’d be happy to make $5/share, or $500 by selling these which would be a strike price of $175. So let’s see what we can do with that information.

Looking at the option chain, we can sell a covered call for a week from now for $3 or $300 per contract. That’s about what we got paid to sell our CSP which makes sense since the strike price is about the same distance from the current stock price as the CSP was. The further out you go, the less you will be able to sell the contract for because the less likely the stock is to move to that price! Who would take a bet that NVDA will go to $300 from $170 in a week from now? I wouldn’t.

And now it’s the same thing, if the stock finishes above the strike price, we will find ourselves having the shares called away at $175, regardless of how high the stock goes. If it finishes at $200, we still get paid $175.

But if the stock doesn’t finish above $175, we continue to hold the stock and we still get to keep the $300 we’ve earned in premium, PER contract! Additionally, if the shares get called away at $175, we get paid the share appreciation as well, which is $5 per share, or $500 for the full contract. When all is said and done, we’ve made $800 in profit! (less any fees from your brokerage, usually a few bucks).

Step 3: Repeat!!

Regardless of which side of the equation we’re on, we simply continue to sell the current type of option until we eventually have shares assigned, or shares called away. That’s why we call it a wheel! Ahhhh yes, it’s all starting to make sense now!

Pros & Cons of the Wheel Strategy:

Pros:

• Simple, low risk introduction to learn option selling

• Generates cash on stocks you like to own!

• You choose your profit up front

• Protects downside when your underlying stock drops

• Very flexible to different market conditions

• Not time intensive

  
  

Cons:

• Limits upside on large price spikes

• The underlying stock can go to zero, which is a risk in owning any stock

• Not as sexy as buying options, “unlimited” gains are not possible

  
  

Final Thoughts: Is the Wheel Right for You?

Do you want to stare at a screen trading options all day? Then this isn’t for you. If you want a low stress set it and forget it method to generate additional income on stocks you like and want to own, you should consider wheeling!

FAQs About The Wheel Strategy in Options Selling:

What is the wheel strategy in simple terms?

• The wheel is a simple strategy to sell options using cash secured puts to enter a position and covered calls to exit a position while generating cash along the way and repeating for as long as you want to.

  
  

How much money do I need to start running the Wheel?

• Recommended to start with around $10k in order to give yourself the ability to incorporate proper position sizing.

  
  

Is the Wheel Strategy safe for beginners?

• Yes! Selling options is incredibly safe compared to buying options. You can think of it as if you are either playing a slot machine that costs $1 to play: Would you rather be the person playing for $10,000 with 0.00001 odds of winning? Or would you rather own the machines taking the $1?

  
  

What are the risks of using the Wheel Options Strategy?

• The only real risks are if the stock you are selling options on is not one you want to own, or one you do not want to hold long term if it drops.

• The other risk is not understanding the goal of selling options to generate income and feeling like you missed out when a stock goes above your strike and gets called away for MAX PROFIT. The stock can continue to go up but you will not go above the max profit level you CHOSE at the onset of the trade.