The Wheel: Easy Premium Collection For Long-Term Holders

The Wheel: Easy Premium Collection For Long-Term Holders

by

So, you found a stock you want to own. You could choose to buy the shares outright — or you could run The Wheel strategy!

It goes like this:

You’re looking at a stock. You want to own it for the long haul. You’re thinking about buying shares. 

BUT YOU DON’T CLICK BUY!

Because you know you could be getting paid to buy those shares.

Instead of buying 100 shares of a stock at $100, you sell… 

A cash-secured put

A cash-secured put is a promise to buy the stock if it drops below $99 (our imaginary strike price) by a specified date. In exchange for making that promise, you get paid a premium!

Here’s the important part: Whether you fulfill your promise to buy the stock or not, you get to keep that premium. If the stock stays above $99, nothing else happens, and you repeat the process, selling a new cash-secured put on the same stock. 

If the stock falls below your strike, congratulations. You’re now the proud owner of the stock you were intending to buy, at a cheaper price than you originally would have bought it for. Your cost basis, which was going to be $100 per share, is now $99 minus the premium you were paid! 

On its own, that’s pretty sweet. You optimized your stock purchase and used options to juice your gains. But that’s just a cash-secured put. The Wheel adds another familiar component.

In comes the covered call 

Now that you own that stock you loved so much at $100, you can sell covered calls against it to collect even more premium! Getting paid just to own a stock? That sounds good to us. And it’s one of the main strategies of Jon and Pete’s Pete’s Covered Calls

We’re effectively trying to lower the cost-basis of the stock you own as low as possible. The strategy works the same, but in reverse. You sell a call option against your 100 shares. That means you’re getting paid a premium in exchange for making a promise to sell the shares if the stock goes up to your strike price by a certain date (the option expiry). 

If the call expires out-of-the-money, you keep the shares and your premium. If the call expires in-the-money, you sell those 100 shares to the buyer of the option at your strike price. Thus reaping both the capital gains from your share price appreciation AND the premium you were paid to sell the option! Just like with the cash-secured put, you get to keep the premium from that covered call at expiration no matter what the outcome is

So let’s recap. 

  • So far you found a stock you loved at a $100 price point. 
  • You collected premium before purchasing it even cheaper. 
  • You sold it for a gain (collecting another premium in the process)
  • Now you have no obligations, no held-up collateral, no shares. 

What happens next?

Rinse and repeat

You start the whole process over again! Sell a cash-secured put for less than the current share price of the stock, yet again collecting a premium in exchange for the promise to buy it. On, and on, and on until you decide to stop.

By all accounts, The Wheel is as beginner-friendly as options strategies come. Despite the simplicity, The Wheel offers four potential sources of revenue: 

  • Premium from selling cash-secured puts
  • Premium from selling covered calls
  • Stock value appreciation (you still make money when the stock goes up, just like if you bought and held)
  • Dividends — if you’re holding the stock during the dividend date, you will collect some additional income

That’s the basic overview of how the strategy works. 

A few nuances to consider

When selling an option, ask yourself if you really want it to expire in-the-money. For instance, if you’re holding shares and you’re ready to get them off your hands, you can sell an at-the-money call. At-the-money options typically have a high extrinsic value anyway due to their ‘up-in-the-air’ prospects, meaning you can collect a little more premium. Conversely, perhaps you think the shares are about to pop! You might then decide to sell a far out of the money, low delta call in hopes that you don’t get assigned. If you do, you’re realizing a steep gain and collecting a premium to sell the stock on top of that!

Another thing to consider is which expiration date to target when selling your options. Generally, options expiring farther out in time offer more extrinsic value (all else being equal). They allow you to collect a higher premium than options closer to expiration (which lose value faster than their longer-dated counterparts). Why? Well, as the chart below shows, that’s when the time-decay really starts to ramp up.

So before writing that option, take a look at the potential premiums that best fit with your style and risk profile. That brings us to our last point. 

The Wheel rolls on

The last question you should ask yourself when running this strategy is “Do I even want to let this option expire?” In Pete’s Cash-Flow Portfolio we almost never let them expire. As you can see in the chart, most of the extrinsic value of an option has melted away by the last two or three days. 

Instead of holding on for those last few pennies, you can roll the option! Rolling is when you close the option you have and simultaneously open a new position in a similar option, but at a different strike price or expiration date. In this example, you would close that old dried-up option to start a fresh position at your expiration of choice. 

Whether that’s fourteen days to expiration or thirty, this allows you to take advantage of the full ramp-up of time-decay all over again. Keep in mind, if the option you sold is going against you, you may end up increasing your cost basis with the roll. But in turn, you avoid the risk of assignment or your option exercised, allowing The Wheel to keep rolling.

No matter how you decide to operate the nuances, The Wheel is a great, beginner-friendly strategy that allows you to collect additional income when compared to a traditional “Buy and Hold” strategy. 

This is only the entry level of premium collection

That said, there are an incredible number of ways to collect premium. If you’re looking for something a little more aggressive, consider using Smart Spreads. The service teaches you how to collect premium from credit spreads featuring trade ideas composed by our Chief Options Strategist Ryan Mastro. 

Smart Spreads combine Ryan’s mastery of the charts with years of experience trading advanced option strategies. Subscribers to Smart Spreads receive his highest probability premium collection plays, and live instruction to manage those trades.  Check out everything Smart Spreads has to offer.

No matter what premium collection strategy you decide to use, what’s important is that you’re trading with discipline, and utilizing options to do it. Because as Jon and Pete always say, 

Discipline. Dictates. Action.

Staying disciplined is how we trade smarter, and it’s what makes us Market Rebels. 

Subscribe to Rebel Roundup for your weekly digest of market highlights and free trading lessons.
We’re on a mission to empower retail traders with the tools they need to succeed.

Join a growing community of traders with Market Rebellion

Join the thousands of users daily!