The idea
A covered call means owning shares and selling a call option against them: you collect a premium now and agree to sell the shares at the strike price if the stock is above it at expiry. A cash-secured put is the mirror image: you collect a premium and agree to buy the shares at the strike if the stock is below it.
The wheel strings them together. Sell puts until one expires below its strike and you buy the shares; then sell calls on those shares until one expires above its strike and they are sold; then start again with puts.
Watch it play out
Step by step
The rules
Setup
- A stock or ETF you would be happy to own at the put's strike price, and the cash to buy 100 shares per contract.
Entry
- Sell a put about a month out, at or below the current price.
Stop-loss
- None in the classic version: the risk is owning the shares as they fall.
Target
- Keep the premium if the put expires above its strike; if assigned, sell calls at or above your cost until the shares are called away.
Filters that help
- Avoid selling just before results or other big events.
- Only use stocks you would hold through a decline.
Why it can work
Option buyers pay for protection and for the chance of big moves. On average, the volatility priced into options has been higher than the volatility that followed, so systematic option sellers have collected a small premium over time, in exchange for giving up the biggest gains and keeping the big losses.
Worked example
A stock trades at $50. You sell a one-month put at $48 for $1.00 ($100 per contract). It expires at $51: you keep $100. You sell another for $1.00; this time it expires at $46.50, and you buy 100 shares at $48, an effective cost of $46 after both premiums.
You then sell a $50 call for $1.00. It expires at $51.60, and the shares are sold at $50. In total: three premiums of $100 plus $2 a share on the shares, $500 on about $4,800 of capital, over three months.
When it works, when it fails
Works best
In flat to gently rising markets, on stocks that move moderately.
Struggles
In sharp falls, when you are assigned shares that keep falling (the premium is small next to the loss), and in strong rallies, when your shares are called away and you miss the move.
Common mistakes
- Selling puts on stocks you would not want to own, just for the premium.
- Choosing high-premium stocks: the premium is high because the risk is.
- Selling calls below what you paid, locking in a loss.
Variations
- Buy-write index
- Owning an index and selling one-month calls against it every month, as Cboe's BuyWrite index tracks.
What the evidence says
Evidence: ResearchedPublished studies exist. Results depend on the details and on costs.
Covered calls on the S&P 500 have been studied for decades through Cboe's BuyWrite index (BXM). Studies found returns close to the index with roughly a third less volatility: better in flat and falling years, worse in strong rallies.
The wheel on single stocks adds stock-specific risk, and research on index options does not cover it directly. The underlying effect, options priced for more volatility than usually follows, is well documented.
Questions
- What is the wheel strategy?
- Selling cash-secured puts until assigned shares, then selling covered calls on the shares until they are sold, then repeating.
- Is the wheel safe?
- It carries most of the risk of owning the stock. In a crash you are assigned shares that keep falling, and the premiums are small next to that loss.
- How much can the wheel earn?
- Premiums of 1 to 2% a month on the capital are common on moderate stocks, but large losses in falling markets can erase many months of them.