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- Navigating Market Volatility with the Wheel Strategy: A Guide to Generating Income Amidst Uncertainty
Navigating Market Volatility with the Wheel Strategy: A Guide to Generating Income Amidst Uncertainty
Weekly Edition: January 29th, 2025
News Snapshot
The Fed meets today for the first time since Trump took office. It could get interesting.
At the time of editing this, there is a 97.3% chance that the Fed will keep rates steady.
On Monday (Jan. 27, 2025), Nvidia lost $600 billion in market cap, the biggest one-day loss in history.
TL;DR
The Fed is holding its first meeting since the start of Trump 2.0. Trump has signaled he wants lower rates, though there is still a 97.3% chance that rates are to remain where they are. So, get your popcorn ready and enjoy the show.
Meanwhile, Nvidia suffered a massive loss of nearly $600 billion in value on Monday, primarily due to concerns about its future performance in AI in relation to its competitor, DeepSeek. NVDA rebounded ~9% on Tuesday, so was this all an overreaction?
‘Good-To-Know’s’
Implied Volatility Crush (IV Crush) - IV Crush is the term for when there is a sudden decrease in an option’s IV, normally occurring after a major event (earnings announcements, economic reports, etc.).
It is hugely important for investors using options to be aware of IV crush, particularly during weeks like this, where there is a selloff, earnings announcements, and/or a Fed meeting. Implied volatility spikes as uncertainty builds, which inflates the options’ premiums. Once the event passes and uncertainty subsides, implied volatility drops sharply. This ‘IV Crush’ can cause a significant decline in premiums, even if the stock moves as expected. However, this can be beneficial for options sellers, as the drop in implied volatility can result in quicker profits from the premiums received.
Quote I Like
“The four most expensive words in the English language, ‘This time it’s different.’”
Thought Throttle
Strategy Highlight: The Wheel
What is it? The Wheel is a fairly straightforward options-selling strategy designed to generate consistent income (in theory) by utilizing cash-secured puts and then, once assigned, incorporating covered calls.
It begins by selling a cash-secured put on a stock you’re comfortable owning, collecting a premium upfront. If the stock price stays above the strike price by expiration, you keep the premium, then ‘rinse and repeat.’ However, if the stock falls below the strike price, the contract is assigned, and you will purchase 100 shares (per contract) at the strike price.
The second phase begins at this point—selling covered calls on the shares you now own. By doing so, you collect premiums for taking on the obligation to sell your shares at the strike price. If the stock remains below the strike price at expiration, it expires worthless—you collect the premium and continue holding the shares. You would then ‘rinse and repeat’ selling covered calls. However, if the stock rises above the strike price, the shares are sold at the strike price, ideally locking in a profit for yourself. Once the shares are sold, you can return to selling cash-secured puts, repeating “wheel.”
I have included a case study below to see this in action.
Case Study
The Wheel Strategy In Action
On May 1, 2024, ‘Guy’ determined that he likes the fundamentals of Cisco Systems and decided to utilize the wheel strategy on the underlying. The ‘May 1st’ stock price was $46.98. He entered into the June 21, 2024, $45 strike Put. Since it is a CSP, he has to secure $4,415 (($45 strike x 100 shares) - $85 Premium Received) for the potential purchase of the underlying:
He goes about his business and allows theta, or time decay, to do its thing. When June 21st arrives, CSCO sits at $46.72/share, and the put option expires OTM. Guy pockets his earned premium and decides that he would like to enter into another CSP:
CSCO had an earnings report on May 15th that made Guy even more bullish on CSCO. Inspired, he entered a CSP position on June 21st, but at a closer strike to increase his likelihood of assignment. Guy decided to sell an ATM (At-The-Money) put with a $47 strike, increasing assignment chances, wanting to own the underlying. Since it is a CSP, he has to secure $4,580 (($47 strike x 100 shares) - $120 Premium Received):
At Expiration on August 2nd, the share price of CSCO was $46.66, and Guy’s ‘sold put’ is assigned. He is obligated to purchase 100 Shares of CSCO at $47/share.
On August 2nd, Guy continues with the wheel strategy, and thus begins selling covered calls. He selects a call that is slightly above his purchase price of the shares. In this case, he selects a strike of $50/share expiring Sept. 20th, and receives a premium of $101:
At Expiration on Sept. 20th, CSCO is ‘In-The-Money’ at a price of $51.97 (Above his $50 strike). Guy’s ‘sold call’ is assigned, which obligates him to sell his 100 shares of CSCO at $50/share. Guy keeps the $101 premium and also receives $5000 for the sale of 100 shares at $50/share.
Let’s see how the math worked out for Guy:
Guy profited $606 after everything was said and done. This is a return of ~13% in about 5 months. This is an annualized return of ~36%. Well done, Guy.
Breakdown
The Wheel strategy can be effective for generating consistent income, but it carries certain risks. Investors must be prepared for potential stock declines, limited upside from covered calls, and the capital commitment required for cash-secured puts (Note that on most platforms, the premium you receive from selling the put option will typically count toward the capital needed to secure the position, as it did in the case study). Market conditions and volatility shifts impact returns, and assignment timing won’t always be favorable. Conduct thorough research to ensure the strategy aligns with your risk tolerance and financial goals.
When implementing the Wheel, focus on stocks you’re comfortable owning long-term. Choose strike prices that match your desired entry point and target expiration dates that balance premium potential and time commitment (typically 40 to 60 DTE). Pay attention to implied volatility—higher IV means larger premiums but also greater price swings.
To maximize success, monitor stock fundamentals and market trends to avoid holding underperforming shares. If assigned, sell covered calls strategically, making sure you fully understand your numbers. Stay patient and disciplined, prioritizing steady income over risky, short-term gains.
Throttle Q&A
What is a protective put?
A protective put involves buying a put option while holding a long position in a stock. Think of ‘Protective Puts’ as insurance on your shares, since the long put will increase in value if the stock price drops (all things equal). It’s useful when you want to protect gains or hedge against downside risk while still maintaining upside potential.
What is Implied Volatility (IV) and why does it matter?
IV represents the market’s expectations of future stock price volatility. High IV means higher option premiums, while low IV results in lower premiums. IV is super important to consider as it affects the cost and potential profit of options.
What’s the difference between buying a call and selling a put?
Buying a call gives you the right to buy the underlying asset, while selling a put obligates you to buy the asset if the option is exercised. While they are both considered bullish on the underlying, buying a call is a net debit (you pay money to enter the position), whereas selling a put is a net credit (you receive the premium). Buying a call also has a limited loss (premium paid) and an unlimited max gain. Selling a put has a max gain (premium received) and a (practically) unlimited downside (not unlimited, but very, very high).
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Disclaimer
The information provided in this newsletter is sourced from reliable channels; however, we cannot guarantee its accuracy. The opinions expressed in this newsletter are solely those of the editorial team, contributors, or third-party sources and may change without prior notice. These views do not necessarily reflect those of the firm as a whole. The content may become outdated, and there is no obligation to update it.
We strongly advise you to consult with a financial advisor before making any investment decisions, including determining whether any proposed investment aligns with your personal financial needs.
