In this article, we are going to discuss the top five must-have attributes that you should be looking for when selecting stocks for the wheel strategy. The wheel strategy as you would probably know is one of the best options strategies for generating consistent income week-to-week or month-to-month.
It is an almost no-lose strategy if played properly with the right stock attributes, which is exactly what we will cover here. This way, you can select the optimal stocks for the wheel strategy.
Without further ado, let’s dive deep into these top five must-have attributes when selecting a stock for the wheel strategy.
Volatility is probably the number one attribute you should look for when selecting stocks for the wheel strategy. If you select a stock that is highly volatile in nature, it becomes very difficult to manage your wheel. As you know, the wheel strategy has two legs – it starts with a cash-secured put and then goes to a covered call.
To run the wheel successfully, you need to make sure you are able to stay in one leg of the wheel for multiple cycles without getting assigned. This ensures continuous rolling is healthy and you don’t have to keep struggling with assignments in both legs.
It is very important to select a stock with medium volatility. The downside of choosing an extremely low-volatility stock is that you will not get much premium income.
On the other hand, you should avoid selecting a stock with very high volatility and frequent price swings. It is a balance – the ideal is to find a stock with medium volatility in the 20-30% range. This way, you can collect sufficient premium without too much of a risk of assignment.
Liquidity is probably the second key attribute to evaluate when selecting stocks for the wheel strategy. Liquidity refers to the volume of trading and investor interest in a particular stock’s options. A stock that has a high daily volume and is actively traded by many market participants is considered highly liquid.
Liquidity plays a very crucial role in options trading. When it comes to rolling, closing out positions, or exercising contracts, liquidity ensures there are ample buyers and sellers for smooth execution. This makes the underlying stock and its options very liquid.
This is critical for the wheel strategy. You may ask why so. because if your position does not go in your favor, high liquidity makes it much easier to roll down options or make adjustments. Hence, it is wise to choose stocks that are highly liquid in nature for running the wheel so that you can adjust it easily if need be.
Another crucial factor is evaluating the fundamentals of the underlying stock. It is very important to run the wheel strategy on stocks with strong fundamentals – ones you would not mind owning if assigned.
If you are unable to close out a position and end up getting assigned stock, you want to ensure it is a quality company. So this is a key attribute to look for when choosing stocks for the wheel.
The stock should have solid financials and fundamentals, and not be a very low market cap or speculative stock. Definitely avoid stocks with poor financials or weakness in their underlying business.
Instead, target stocks with strong, stable fundamentals – ideally in the mega-cap space. The high quality and financial strength will give you confidence in holding the stock for the long run if ever needed when running the wheel.
Dividends are another factor worth considering when choosing a stock for the wheel strategy. Dividends can provide a cushion by reducing your cost basis if you have to hold the stock for an extended period.
Let’s say you start the wheel with a cash-secured put and eventually get assigned 100 shares of stock. If that stock pays a dividend, you will receive extra income for the duration you hold the shares and sell covered calls against them. So you benefit twice – from the usual premiums plus the dividend.
That’s why, if possible, choose a stock that pays a dividend. This gives you an additional stream of income if assigned to the shares for the longer term. However, it may not always be feasible to find a stock that has solid premiums, meets all the other wheel criteria, and pays a dividend.
So consider the dividends as a nice-to-have attribute when selecting wheel stocks. While not absolutely essential, stocks with dividends can provide valuable extra income if you happen to be assigned shares and need to hold the stock for an extended period as you work the wheel strategy.
Last but not least is the beta value. As we discussed earlier, volatility – which is important when selecting a stock for the wheel – mostly looks at historical volatility and price swings with respect to the stock itself.
Beta value, however, is forward-looking. It aims to assess the expected future volatility of a stock. Additionally, beta considers volatility relative to the broader market, as opposed to just the stock’s standalone price action like historical volatility does.
A lower beta value implies the stock is less sensitive to price movements in the overall market. A higher beta means the stock tends to experience wider price swings and is more reactive to market volatility.
That’s why, when choosing a wheel strategy stock, look for ones with lower beta values. This indicates the stock is less prone to major price fluctuations directly in correlation with market volatility. And that makes it a perfect candidate to run the wheel.
In summary, I would say that the key to running a successful wheel strategy lies in these five must-have attributes. When selecting stocks for the wheel strategy if you can ensure that all of them are checked then you have a solid chance of generating consistent income using the wheel strategy.
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