How to Find the “Best” Stocks for the Wheel Strategy

Last updated: September 4, 2024

If you’re looking for a way to generate income from your investment portfolio and you’ve already explored the traditional methods of dividend stocks, bonds, etc., learning to sell options can be another way to generate income (or premium) from stocks you already own or the available cash in your brokerage account.

In this article, I want to give you a brief introduction to how the wheel strategy works, show you what makes a “good” wheel stock, teach you how to find the best stocks for yourself using a tool, and give you a short list of some stocks to get you started on the wheel strategy.

Let’s roll… Did you see what I did there? Wheel… Roll? Ok, never mind…

What is the Wheel Strategy?

At the risk of oversimplifying the whole thing, here is a quick overview of how the wheel strategy works.

The Wheel Strategy, or “Options Wheel Strategy” as it is sometimes called, combines the two strategies of cash-secured puts (CSPs) and covered calls (CCs). When everything goes according to plan, the wheel strategy should generate income consistently. Plus, the strategy gives you the potential to benefit from dividends and possibly even appreciation of the stock price.

What is a wheel strategy “campaign”?

If you spend any amount of time on our site or watch our YouTube videos, you’ll consistently hear us refer to “campaigns” instead of just “position.” A wheel campaign can be very short-term, or as you’ll learn below, it can go on for many weeks or months. You may take many “positions” or “trades” during an extended wheel campaign.

The Life-Cycle of a Wheel Campaign

There is no one “right way” to open a wheel campaign. For the purposes of this explanation, I will start the campaign with a cash-secured put. Here are the typical stages of a wheel campaign:

1. Sell a Cash-secured Put
   You start by selling a put option on a stock you are comfortable with owning at a strike price below the current price at which you are comfortable owning the stock. You receive the premium immediately for this CSP. That’s cash in your account that you keep no matter what happens with the rest of the campaign.
   
2. If assigned, sell a covered call
   If the stock price dips below your CSP strike price, you must buy the shares of that stock at that price. This is called being “assigned.” Whatever price you paid for the stocks, we will now refer to as your “cost basis”
   After assignment, you turn around and sell a covered call at a strike price at or above your cost basis. You again receive a premium immediately. That’s more cash money in your account.
   
3. If called away, start over
   If the stock price goes above the strike price at expiration, your shares will get “called away,” meaning you will sell them at the strike price. Now that your shares have been sold, your open risk for this campaign has gone to $0, meaning the campaign is closed. You’ve got back all of your cash PLUS the premiums you received on the CSP and CC. Now it’s time to go out and find more premium to plunder!

The cyclical nature of this campaign is what earned this strategy the nickname of the “Wheel Strategy.”

Wheel Strategy Example Campaign

Let’s walk through an example of a fictitious wheel campaign together using a fictitious company, so it isn’t confused with anything actively trading in the market. Suppose you found a stock you like in the market, call it NoName Corp, that you are comfortable owning for a long time at a price similar to what it is currently trading at, which is, let’s say, $25 per share.

Here’s how the campaign might play out

1. You sell an out-of-the-money cash-secured put on NoName Corp at a $20 strike price that expires in 30 days. You receive a $50 premium on this trade.
   
2. Your broker will take cash from your account and hold it as collateral against this trade. A single options contract is for 100 shares of the underlying stock. So your broker is going to take ($20 strike price X 100 = ) $2000 of your cash and hold it as collateral.
   
3. The stock price of NoName Corp falls below $20 on the expiration date. Since you sold a put, you must purchase the stock for $20 per share. Your broker will use the cash it holds as collateral and do this for you.
   
4. You now own 100 shares of NoName Corp at a $20 cost basis.
   
5. Now, you sell an out-of-the-money covered call on your newly acquired shares with a strike price of $20, expiring in 30 days. You receive a $75 premium.
   
6. The price of NoName Corp increases to $22 on the expiration date, so your shares get assigned and you must sell them for $20.
   

At the end of this campaign, when your open risk goes to $0, you generated $125 in premiums on the sale of the CSP and CC. Your total return is $125 premiums / $2000 open risk for a 6.25% return on your investment on a campaign that was open for about two months.

How to Choose the “Best” Wheel Stocks

I learned a very long time ago that nearly EVERY trading strategy works if you consistently choose the right stocks. If you are a buy-and-hold investor who bought NVIDIA in 2003, you probably feel good about life. However, it’s completely unrealistic to think that you’re always going to be right. You have to focus on the process of choosing the right stocks and prepare yourself for the inevitably that you might select a stock that looks like a great candidate that turns out to be a dud. Focus on the process, learn (and heed) the principles of risk management and diversification, and buckle up for what sometimes can feel like a bumpy ride. If you do this, you can probably make the wheel strategy work for you.

So what should you look for to find the “best” wheel stocks? First of all, the term “best” really bothers me because it is completely subjective. Best could mean the absolute highest premium regardless of timeframe, it could mean that it is a stock that moves sideways, or really any number of things. So while everyone wants to ask the question, “What are the best wheel stocks,” I’m going to answer the question, “What makes a stock an ideal candidate for the wheel” because that is really the root of what everyone is after. If you focus on “ideal” versus “best” you’re likely to end up with a larger pool of stocks to choose from when running the wheel. More stocks = more diversification = more premiums to explore. I’m seriously not ever going to let up on preaching diversification, especially when running the wheel strategy.

Good wheel stocks are always stable, large-cap and mega-cap stocks you’re comfortable owning for the long term. Many people will say it should be a dividend-paying stock as well, but I believe that when you limit your scope to dividend-paying stocks, you’re ignoring stocks that have premiums that would earn FAR more than whatever dividend many stocks carry.

The most significant risk involved with the wheel strategy is that the stock price decreases significantly or the entire company implodes and the stock goes to $0. We’re looking for companies that are not going away any time soon. But remember, there is no such thing as “too big to fail.” Don’t put your entire portfolio into a YOLO trade because you think that company is going to the moon. “T-R-Y to DIVERSIFY!” - said like a cheerleader.

Here are other characteristics of good wheel stocks:

• Mid-Range Volatility - Highly volatile stocks can lead to bigger price movements, more frequent assignments, and more risk. Volatility is typically rewarded with higher premiums, but we don’t want to be on a rollercoaster, we’re looking for consistency. A stock with very low volatility will have very low premiums and won’t earn much on your open risk. We’re aiming for a sweet spot in the mid-range of volatility.
• Liquidity - You need to be able to move in and out of a position quickly and not end up owning a stock you can’t sell. Honestly, if you stick to large-cap and mega-cap stocks, this shouldn’t end up being a problem.
• Trading at, or below Fair Value - A stock's “fair value” is what you (or someone else) believe a stock should be trading at based on its fundamentals. Many traders prefer to calculate their own fair value of a stock. Personally, I rely on the MorningStar fair value. The further below the current price is from the fair value, the higher the percentage is of what is called “discount-to-fair-value.” All other things being equal, a stock with a higher discount to fair value (DFV) is a better wheel candidate than one with a lower DFV.
• Low(er) Risk of Kaboom - If there’s a particular sector that you are averse to, you probably want to exclude stocks in this sector from being considered good wheel stock. Remember that the biggest risk in the wheel strategy is a company going to $0. In my lifetime, most of the major companies that I’ve seen implode themselves are in banking or financial services. For this reason, I generally exclude them from consideration as wheel stocks. This is a personal preference.
• Dividend Paying (sometimes) - Conventional wisdom says that wheel stocks should be dividend-paying stocks. While I will 100% agree that all other things being equal, a stock that carries a dividend is a better wheel stock than one that does not, it is rare that everything else is equal. Suppose a stock I’m evaluating meets all of the other criteria of a good wheel stock and has absolutely sick premiums. Why on earth am I going to dismiss it in favor of another stock just because it has a measly 1% dividend?

How to Screen (or Scan) for Wheel Stocks

Some option scanners can make identifying opportunities for wheel stocks easier once you know what you are looking for. However, It is important to remember that results from a scan are just information or a starting point for research. When used correctly they can save a tremendous amount of time and energy that you would otherwise have to put into manual research.

In your wheel strategy research, time is more enemy than friend. Market prices are in constant motion. If it takes you 24 hours of research to find a wheel trade, the odds are high that the trade you originally identified early on in your research either no longer exists or is significantly different. Don’t be afraid to leverage tools that streamline this process for you.

Premium Pirates is one of the best options screeners, and really the only one designed from day one with wheel traders in mind. Why? Because we’re wheel traders ourselves. This tool never existed before. We desperately needed it, so we built it ourselves!

The Premium Pirates option scanner makes it incredibly easy to scan across literally thousands of stocks evaluating every strike at multiple expirations using real-time pricing data. You can filter for opportunities based on a number of factors, such as market cap, sector, implied volatility, and much more. You can even score discount-to-fair-value to find stocks that are trading at a deep discount with abnormally high premiums that you otherwise would never be able to find. This is how to do premium plunderin’ at its finest!

You can create watchlists, save scanning criteria, and track all of your wheel campaigns over time. There’s no other suite of tools out there that can help you become a better wheel trader as quickly. I encourage you to sign up for a free trial and try it out for yourself.

Top Starter Stocks to Run the Wheel Strategy

SPY

SPY is an ETF, not a stock. It closely follows the performance of the S&P 500 index and holds the distinction of being the largest and oldest ETF. This fund can be a good starting point to learn the wheel strategy

Pros:

• Well-diversified across hundreds of stocks
• High liquidity
• Low(er) volatility

Cons:

• High share price - At the time of this writing SPY is trading for $561. Remember that one options contract is 100 shares. To open a CSP below the current price, even way out-of-the-money at a $525 strike price would require $52,500 in collateral

TQQQ

Again, this is an ETF, not a stock. It’s also a leveraged ETF, which is a higher risk/reward. This ETF uses a 3x leverage against the NASDAQ 100. While risker than starting with an ETF like SPY, it does have some advantages

Pros:

• Well-diversified across 100 stocks
• High liquidity
• Higher premiums than other ETFs
• Lower share price - while SPY is $500+, TQQQ is trading at just $68 right now. To open a single options contract would only require $6800 in collateral.

Cons:

• Higher volatility - A leveraged ETF will have more wild price swings than one that does not. Proceed with caution.

T

AT&T has lost favor over the years as a good candidate for a wheel stock. However, if we’re talking about “starter” wheel stocks, I still believe this a great one to learn on. It meets all the criteria of a good wheel stock and is currently trading for less than $20. If you’re trying to learn how the wheel strategy works and you might make mistakes (you probably will), it’s best not to put a ton of capital at risk.

Pros:

• Low volatility
• Low share price - less than $20
• 5.6% dividend yield

Cons:

• Low premiums can be really low. Use this stock to learn the wheel. Eventually, you’ll move on from it, but make your mistakes here.

F

Ford Motor is a very old company with 170k+ employees and a $44B+ market cap, and it will probably be around for a while. It is trading for $11 at the time of writing, so the collateral needed to sell a cash-secured put is well within reason. Again, this is a stock that is a great “starter wheel stock” to learn on. You can figure out the mechanics, make your mistakes, and improve without a ton of open risk. You might eventually move on, but I still open F wheel campaigns when the premiums are right.

Pros:

• Low volatility
• Low share price - less than $12
• 7.07% dividend yield

Cons:

• Moderate premiums
• You might drive a Chevy

Some Good Wheel Stocks for the Rest of 2024

I found all these stocks using the Premium Pirates Option Scanner, which you can try for free anytime. What I like to look for on the option scanner are stocks that are trading at a discount-to-fair-value ( the bigger the better) and have abnormally high premiums with a level of volatility I can tolerate to justify the return.

These are the exact settings I used in the option scanner to produce these wheel stocks:

• Expirations through Dec 20, 2024
• Delta < .04
• Market Cap $9B+
• Limited to my Popular Wheel Stocks watchlist
• Discount to Fair Value of 1 star or more
• Cash secured puts only

BBY

At the time of writing, it is currently trading slightly above its Morningstar fair value. However, I can write cash-secured puts below the fair value and still find excellent premiums. The retail sector has been in uncharted waters for the last few years, but Best Buy still has a $21B+ market cap, carries a 4.24% dividend yield, and boosts excellent returns with a moderate IV.

CHWY

This is another stock that is trading right at its Morningstar fair value at the time of writing. But remember, you don’t have to choose strike prices that are at the money. I can still look at out-of-the-money strikes that give me the discount-to-fair-value I desire if I get assigned. The premiums even before the next earnings announcements are exceptional. This one might be worth looking at again.

DG

Dollar General is currently trading at $87 versus a Morningstar fair value of $145. Have I mentioned before how much I like a big discount-to-fair-value? Some CSPs that expire a few months out have higher implied volatility than I would like, but some shorter-term positions have excellent premiums.

HPE

With a $24B market cap. 2.68% dividend yield, and a current 22% discount-to-fair-value, Hewlett Packard is everything I’m looking for in a wheel stock. Looking out about a month, I can open a CSP with a 3.2% return with a delta of only -0.34. I will be investigating this one!

What comes next?

Hopefully, this article taught you what you need to know about narrowing down the stocks that are good candidates for the wheel strategy to a manageable pool. Again, I can never encourage you enough to learn all you can about risk management and diversification. They are your best friends when learning to run the wheel. The wheel, like all trading strategies, involves risk. Having a good foundation of knowledge, using tools like Premium Pirates, and doing your own research can help mitigate those risks and help you maximize the income you can earn.

Make sure to sign up for a free trial of Premium Pirates. It’s fully functional and will produce some eye-popping returns that you may have overlooked otherwise.

Now get out there and do some premium plunderin’ & market raidin’