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As a beginner, options trading seems a very difficult skill to learn as there are lots of different concepts that you have to learn at the same time. It can be quite overwhelming at the beginning. Luckily there is a plethora of free information at your fingertips if you are willing to put in some time.
Two resources that I have found useful are
- https://tradersacademy.online/trading-topics/options/basic-option-strategies from IBRK
- https://www.youtube.com/watch?v=7PM4rNDr4oI Project Finance on you tube
Between the two links above, you should have enough information to get started.
Option Basics
If you have experience with options trading then you can skip this part. I will keep it quite high level for those who maybe have not heard of options before.
There are two main components to the wheel Strategy which involve Selling Put and Call options. So what does this mean?
- Buyer of a Call – Has the right to buy an asset at a pre-determined strike price
- Seller of a Call – Is obligated to to sell an asset at a pre-determined strike price
- Buyer of a Put – Has the right to sell an asset at a pre-determined strike price
- Seller of a Put – Is Obliagted to buy an asset at a pre-determined strike price
You should be absolutely sure that you understand these before you even think about playing with options.
The Wheel startegy
The wheel strategy starts by selling cash-secured puts. Here are a couple of things that I have learned over the last year of doing this.
https://www.buymeacoffee.com/dividendtalk
- Do not chase premium, sooner or later you will get burned
- Only buy companies that you want or do not mind owning for at least a year or more
In step 2 the put with either expires worthless or the put expires in the money and the stocks are assigned. The good news is that in both scenarios we get to keep the premium.
If the put expires worthless we can then recycle the cash and start the whole process over at step 1. If we are assigned then we need to move on to step 3.
As we now own 100 shares of the company we can start to sell covered calls. Ideally, the covered call strike price should be equal to or above the price we were assigned the shares at.
Similar to step 2, the Call will either expire worthless or the call expires in the money and we are obliged to sell the shares at the pre-determined strike price.
If the call expires worthless, we still keep the 100 shares and we repeat the process of selling covered calls. Also as the stocks will all be dividend stocks if we hold the stock through the ex-dividend date we will also collect the dividend on the way.
If the call option finishes in the money we no longer own the 100 shares and the wheel is complete. The best thing about this strategy is that we have earned put premium and call premium. We may have also earned dividend income and capital gains depending on how long we owned the stock for and the strike price we sold the call at.
So what are the risks?
There are two main risks or downsides to this strategy. When selling puts I am obliged to buy 100 shares of the stock if the share price is below your strike price. It doesn’t matter how low the stock drops. For example, if I sold a put on Microsoft at $200 and the price dropped to $100. I am are still required to buy the shares at $100.
Not only have I got 100 shares, but now selling covered calls at or above my strike price is out of the question as the premium is too low. This is why I only choose companies you would like to own long-term. I have learned this the hard way as I am now the (un) proud owner of top-quality garbage companies such as $WISH and $SOLO. By focusing on dividend stocks even if the price drops, I will be able to collect the dividend while waiting for the price to come to a level where I can sell covered calls.
Speaking with calls. I would only sell calls on companies you don’t mind selling and I would not sell calls below your original put strike price. I found this out with ENAGAS. A Spanish utility company. I originally sold a covered call to make a little extra cash. However, the price actually finished €2 more than my strike price. I was forced to sell and missed out on €200 in capital gains, it also happened to be just before the ex-dividend date so I missed the juicy 8% dividend yield as well. It was a double whammy as I didn’t want to sell the company and if I did it would cost me €200 more than I sold them for and the put only made me an extra €50.
How I pick my Stocks to sell puts
For my March 2022 options watchlist, I like to keep it simple so I use finviz with the following filters
- Market Cap over 10 billion
- EPS Growth is positive over the last 5 years
- Sales Growth is positive over the last 5 years
- Payout Ratio under 70%
- the are 5% or more below away from their 52 week high/low
- Not over bought in 14 day RSI
- Average volume of 1 million or more
Running this gave me the following 35 companies to choose from.
There is no exact science to the next part, I simply remove any company that I either don’t own or have no interest in owning.
My next step is to find the put premium for the next month at roughly 1 standard deviation away from the current price. I use my spreadsheet to calculate the annualized ROI for the option.
Generally, I like to pick securities where the annualized ROI is above 12% which leaves me with a march 2022 options watchlist of $CMCSA, $MMM, AND $TROW.
Current Open Put Positions
I currently have three positions open with $INTC, $SOLO, and $OHI.
$Solo is a disaster and a constant reminder that I should not chase premium and only choose companies I want to own long-term. I am hoping to average down on this and I can sell a covered call at around $3 and hopefully break even or make a small loss.
$INTC is a company that is on my list as a turnaround play. Those who listen to our podcast, Dividend Talk, will know that I think it will take at least another 18 months before we will start to see if the new CEO Pat delivers on his promises. I would be morse than happy to own this company at $40.
$OHI is a high-yielding dividend stock that also has some nice premium. While the company is not high on my purchase list but I would be more than happy to collect a 10% dividend yield while “wheeling” this company.
Current Open Call Positions
I have 2 open covered calls. $CCL which I was assigned around June of last year. I felt at the time when it looked like corona was starting to ease a little that the world would slowly open up and people might begin to go on cruises again. What actually happened was that we were hit with a couple more waves since. However, I have been able to sell 2 covered calls since and my average price is $25. I am happy to hold this company this year and see what happens if the world can get back to traveling soon. If I am assigned in June, not only will I keep the premium but I will have made an extra $250 in capital appreciation.
Tobacco stocks have been in a downward trend over the last couple of years and Altria hasn’t closed above $52.60 since June 2019. I have an average buy price of $47 and have been wheeling this company and collecting the dividend for the past year.
It’s not on here yet, but I was assigned 100 shares from my Pfizer put in February and will begin selling covered calls on the company from next week.
February Options Summary
In February so far I have made $456 in premium from 6 different companies. I closed out Fresenius, Viatris, and Intel at around 50% profit. Pfizer was assigned to me this month as discussed above. I closed Wish and CCL after holding them for a week as most of the profit was already made.
Just after finishing writing this, I got rid of my $BABA put. I opened up $BABA when it dropped to around $135 and expected it to rebound quicker. My expectations proved incorrect. In most circumstances, I would have been happy to hold this to expiration and be assigned BABA. However with the war in Russia and the uncertainty in the market. I prefer to have a “sleep well at night” portfolio. Volatility was increasing and the possibility of increased margin requirements and a market correction meant I bought the put for $27.
As a result, I have made a loss for only the second month ever. I have down $674 this month and $38.65 for the year.
However, I have freed up some capital and I can sleep a little bit better if the market does drop
Recommendations
Simply Investing Report review – For investors who might like to have all the research done for them
Sure Dividend – Ben and his team help individual investors build high-quality dividend growth portfolios for the long run and offer a lot of excellent content for free. I write company review articles on Sure Dividend each Quarter.
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