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- Tariffs, AI, and Options: The Wheel vs. Covered Strangle in a Wild Market
Tariffs, AI, and Options: The Wheel vs. Covered Strangle in a Wild Market
Weekly Edition: February 5, 2025
News Snapshot
The Trump tariffs are now live for China, but Canada and Mexico have been delayed.
Palantir’s stock is on a rocket ride, now sitting at ~$104.
Bond traders are sweating as short-term Treasury yields jump.
TL;DR
Recent trade policy shifts and economic data have injected volatility into markets. U.S. Treasury yields rose after new tariffs on Chinese imports were announced, while delays on Mexico and Canada’s tariffs added uncertainty. This has investors second-guessing interest rates and economic growth—because nothing says "market stability" like a fresh batch of trade drama.
At the same time, Palantir Technologies is hot right now after crushing earnings expectations, fueled by strong AI adoption. Its nearly 500% year-over-year gain highlights investor enthusiasm for AI-driven businesses, even amid broader economic uncertainty. The ‘market’s mood’ swings between ‘trade chaos’ and ‘AI euphoria’ faster than a day trader after a double espresso.
These factors are driving shifts in equity options pricing. Bond market uncertainty is pushing implied volatility higher, increasing option premiums. Trade concerns may spur demand for protective puts, while Palantir’s strong earnings could drive call option interest. In this market, options traders need to stay sharp—because one headline can turn a winning trade into a “learning experience” real quick.
“Good-To-Know’s”
Bid-Ask Spread: This is the ‘gap’ between the ask price (your ‘Buy’ price) and the bid price (your ‘Sell’ price) for an option. It is the difference between the highest price that a buyer is willing to pay and the lowest price that a seller is willing to accept.
It is important to understand this concept since it is a cost to your options trade (and is amplified with multi-leg options strategies). We want the SPREAD to be as NARROW as possible. To highlight this, compare AAPL to CCL.
AAPL
The Bid-Ask Spread on AAPL’s ATM Call (230 strike) is ~1.5% ([9.65-9.50]/9.65). This is a very narrow spread, and is what we like to see before entering a position. Now compare this to Carnival Cruise Line’s Options Chain.
CCL
CCL’s Bid-Ask Spread for the ATM Call (27 Strike) is ~13.5% ([1.70-1.47]/1.70). This is a higher and less appealing spread compared to Apple. It can largely be attributed to Apple’s greater trade volumes and overall prominence over Carnival. The spread needs to be considered before entering a trade, as it can certainly change the outcome.
Thought Throttle
Options traders looking for steady income often turn to premium-selling strategies, but the approach they choose can greatly impact risk, reward, and capital efficiency. Two methods known in the community for generating income are the Wheel Strategy and the Covered Strangle. While both involve options writing, they differ significantly in structure and risk exposure.
The Wheel
The Wheel is a powerful systematic approach designed to generate income while accumulating shares at favorable prices. It consists of three main steps:
Sell a cash-secured put: If the option expires worthless, the trader keeps the premium and repeats the process. If assigned, the trader buys the stock at the strike price.
Sell a covered call: Once shares are acquired, the trader sells a call option at a higher strike price, collecting additional premium.
Repeat the cycle: If the call option is exercised, the shares are sold at the strike price, and the process restarts with selling another put.
ly
This is “The Wheel” for dummies:
Covered Strangle
The Covered Strangle is an income-enhancing strategy that involves owning the underlying stock while selling both a covered call and a cash-secured put simultaneously. Unlike the Wheel Strategy, where the trader only sells a put initially, the Covered Strangle begins with a stock purchase and immediately layers on two income-generating options:
Buy the stock: The trader takes ownership of shares at the market price.
Sell a covered call: This generates premium but caps upside potential if the stock rises beyond the call’s strike price.
Sell a cash-secured put: This brings in additional premium and creates an obligation to buy more shares if the stock drops to the put strike price.
This is “Covered Strangles” for dummies:
Pros and Cons
Features | Wheel Strategy | Covered Strangle |
|---|---|---|
Risk Profile | Moderate (Gradual Exposure through Puts) | Higher (stock owned and potentially more shares if the put is assigned) |
Complexity | Single leg strategy; much simpler | Multi-leg strategy; more management required |
Income Potential | Moderate; Consistent (1 Sold option leg at a time) | Higher (Premiums from both calls and puts); Also, can incorporate margin for the original stock purchase |
Capital Requirements | Cash to secure the Put | Requires capital for stock purchase plus cash to secure the Put |
Outlook/Bias | Neutral to Slightly Bullish | Neutral to Slightly Bullish |
Final Analysis
The choice between the Wheel Strategy and the Covered Strangle depends on your risk tolerance and trading style. The Wheel Strategy is ideal for conservative traders who want a simpler and more ‘hands-off’ options strategy to generate income. The Covered Strangle, on the other hand, is more aggressive and best suited for traders wanting to maximize premium income. It provides higher cash flow but comes with the risk of being forced to buy more shares if the stock drops, increasing exposure to a potentially declining asset.
Both strategies are excellent tools for options traders looking to generate steady returns. Understanding these differences can help traders choose the strategy that best aligns with their goals, risk tolerance, and market outlook.
Before committing capital, traders should consider backtesting these strategies and starting with small positions to understand how they perform in different market conditions. Regardless of which strategy you choose, risk management is key to long-term success in options trading.
Important Note: While a line is drawn between these strategies in this article (for the sake of a simple comparison), these strategies can blend and don’t have to be so rigid. You can start off with the wheel, and then upon assignment of the cash-secured puts, you can sell both call options and put options. Then, later, if you wish to exit the position, you can sell only covered calls, etc. There are huge ‘mix and match’ opportunities, and (obviously) there is more nuance to each of the strategies.
Next Steps
Learn further about these strategies, practice with paper trading, consult with a reputable financial advisor for situation specifics, and get started.
Relevant Quote I Like
“I’ve always preached to my clients that how you do in bad markets is more important than how you do in good markets. Managing your risk is more important than finding avenues to make money.”
Throttle Q&A
Which strategy is better for beginners?
The Wheel Strategy is generally easier for beginners because it allows for step-by-step risk exposure rather than buying shares outright. It also maintains simplicity by only selling one option at a time.
The Covered Strangle requires more capital and risk management skills since you're committing to both stock ownership and additional share purchases upfront.
Which strategy is safer?
The Wheel Strategy is generally considered safer because you are gradually gaining exposure to the stock rather than owning it outright from the beginning. Your delta exposure is lower than selling a put and buying the underlying.
The Covered Strangle, on the other hand, exposes you to double risk—if the stock declines, your long shares lose value, and you may also have to buy additional shares due to the short put.
Can I adjust these strategies if the trade goes against me?
Yes! Both strategies offer adjustment techniques:
For the Wheel Strategy: You can roll the put to avoid assignment or roll the covered call higher if the stock moves up.
For the Covered Strangle: You can roll the put down to lower your potential entry price or roll the call up to capture more upside.
What are the tax implications of these strategies?
Both strategies involve short-term capital gains on options premiums, which are taxed at ordinary income rates. If shares are assigned and held long-term (at least a year and a day), you may benefit from long-term capital gains rates when selling. Tax rules can vary, so consult a tax professional if trading these strategies frequently.
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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.
