Theta Gang, The Wheel Strategy – FAQ

What is the theta gang wheel strategy?

Theta gang is the idea of selling options for premium and collecting on the time decay of the option, called “Theta”. One of the more popular strategies in this category is known as “The Wheel”. We outline execution of the wheel strategy in great detail in this post from our blog. Here are some other frequently asked questions that we’ll cover to ensure you know all the ins and outs of the strategy. Alternatively, if you want to see the Wheel working in action. We’ve created this AI bot that automatically trades this strategy on a handful of tickers. What the bot does is it will sell puts to open at approximately -0.20 to -0.30 delta (delta is always negative for put options) when certain stocks are having a red day. The expirations will be between 4-5 weeks and if by expiration the bot is assigned the shares, it will begin to sell covered calls against the shares to lower the cost basis until profitable.

What is Theta for options?

Theta is one of the Greeks when trading options. In simplest terms, theta is correlated with the “time” value of an option that is associated with time decay. When looking at a the Theta value of an option it is normally represented by a value of how much the option value is lost per day.

What are some of the other popular option selling strategies?

There are various investing strategies that utilize selling options for premium. Most of these include selling spreads, short iron condors, short strangles, and the wheel strategy. The wheel is one of the strategies with the lowest risk profiles, while selling spreads can begin to have an increase in risk.

How do I make money selling options premium?

When you are selling option spreads such as short spreads, short iron condors, short strangles, or covered puts (aka the Wheel) you are essentially selling options and collecting a premium instead of buying the option outright. Being on the short side of the option, also known as writing the option and putting in a ‘Sell to Open’ order, you are able to collect premium daily, weekly, or monthly from the Greek value of “Theta” from the option. In options trading, “Theta” is another word for “time”, so as time goes by, the option that you sold will begin to lose value to the buyer, and gain value to the seller (you) as long as the underlying stock price isn’t going against the direction of your position too quickly. “The Wheel Strategy” that we will be focusing on, is a strategy that mainly includes selling puts for income.

How do I sell puts for income?

The best way to sell puts for income is to run a low-risk options strategy called “The Wheel Strategy”. The wheel strategy involves selling a covered-put, which lowers your risk profile and ensures you don’t over-leverage your account. The idea behind this is to sell puts at a strike price you are willing to own the stock for the long-term. By selling puts for income you are betting that the stock price will either stay flat or go up and you will be able to collect on theta each day that passes by. What’s great about selling puts is that depending on the expiration date, usually 1-6 weeks out, you can collect premium and earn an income consistently similar to a dividend.

Should I ever sell naked options?

The wheel strategy involves selling naked puts, also known as cash-secured-puts, which means you are able to cover your losses should a black swan event happen and the stock goes way down. We wont’t be going into much detail on call options in this post, but personally when it comes to call options I would never sell them naked, there is too much risk. Selling cash-secured-puts has a much lower risk profile and is a great way to collect premium even for a risk-averse individual who is simply trying to make extra income by selling options.

How can I limit my risk when selling put options for income?

There are two ways you can limit your risk to the downside if you are selling puts for income and running the wheel strategy. First, you can always buy to open a put option with a strike price way further down than the strike price of the short put option you sold. For example, if AAPL is trading at $100. You sell the $95 put option for $5 and purchase the $50 strike put option for 5 cents. This limits your risk should the stock go to zero if AAPL one day happens to declare bankruptcy. Why not do this every time? When you open a spread like mentioned above it will cost you anywhere from $1-5 and possibly a $1 fee depending on your broker. If you sell weekly options 52 times a week, that would end up cutting $250 from your profits for each ticker you sell puts on. Will AAPL declare bankruptcy anytime soon or the stock price dip that low? Probably not, but the chance of it happening is greater than 0% (and probably less than 0.005%). The second way to limit your risk when selling put options for income is to sell at expiration dates further than 1 week out. Selling weekly puts will be more risky than selling them 4 weeks out. However, as we will mention in the section below, put options will begin to gain more on the Theta curve at approximately 4-6 weeks out from expiration.

What expiration and Theta should I be selling options at?

Generally speaking, the sweet-spot to collect maximum theta on options is at about 4-6 weeks. If you scroll through your broker/trading app and look at the same option chain for the same strike price from 4-6 weeks out and then compare it to the same option chain at the same strike price 3-6 months out, you will notice the “Theta” value of the option chain is much less. Selling the option expiring in 6 months will yield you pennies per day on Theta, whereas selling only a few weeks out will probably net you $10-20 per day. You will need to evaluate your strategy and maximum risk tolerance to decide how far out you want to sell puts. Do you want to do it weekly? Do you want to sell monthlies? Etc.

Does delta matter when selling puts and what is a good delta for options?

Personally, I think of Delta as the probability that the put I sell will go against me. If I am selling the -0.20 Delta put then I am looking at it like there is a 20% chance my option will expire in the money and I will get assigned. Taking away the negative sign for put options the lower delta will provide less premium, but also there is a greater chance of it expiring worthless where you collect the full premium. If I am feeling very confident in the price level of the stock and that we’ll see more upside from the current price I might sell the 0.30 delta which will yield a higher return accompanied by a slightly greater chance that my position will go against me.

What are the downsides and upsides to the wheel strategy?

The wheel strategy is most efficient when markets are either slightly down, slightly up, or flat, and when volatility is up. If the market is having large swings up and down, that is actually okay. It’s when the market enters a bear market and stocks continuously go down, or when the market is in a big bull run where it only goes up, that much of the benefit from the wheel strategy is lost. In bear markets when stocks are going down heavily you will get assigned the shares and will be forced to hold. Unless you have additional capital sitting on the sidelines to “buy the dip” you will end up holding shares for the long-term. On the other hand if it is a big bull run and stocks go up day after day your 3-4% monthly gains from wheeling stocks will be chump change to a market that is going up 10% monthly.

What stocks are the best for running the wheel strategy?

The key to running the wheel strategy and selling put options is volatility. We need premiums on options to be high so that the return from selling options is enticing to take on the risk. If volatility is low, it might not be worthwhile allocating capital to a cash-secured-put for only a 0.5% gain in 3 weeks. However, if volatility is high, we can potentially look for stocks that will return anywhere from 4-10% return in just a month. The best way to find whether a ticker has high premium options is to look at the implied volatility of the option chain.

How can I find high IV options?

Normally every broker/trading application will provide you with the option chain’s implied volatility. The IV changes for each strike and each expiration, but they will all usually be pretty similar in value. Certain events such as an earnings report will give a boost to premiums and increase implied volatility on options for that stock. Sometimes looking at individual tickers in your broker and looking up option chains can be quite time-consuming. Check out Swaggy’s FD Rankr, a tool that compares average implied volatility for almost 1,000 tickers available to trade. You can sort the list by implied volatility from least to greatest value, by next earnings date, and also by the stock price which will help find cheaper stocks for small accounts to run the wheel on. Here’s a screenshot of the tool.

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