I’m undertaking a 1000-day reinvention project, blogging here daily to track my progress. In Monday Money, I write about money management.
About a month ago I wrote about an alternative to buy-and-hold investing: swing trading. I started putting that into practice a little and had some success but have chosen a different way forward at this point: the options wheel.
With the options wheel, you sell cash-secured (or naked) puts which pay you a premium and may require you to buy a stock (or ETF) at the strike price, should the price of that stock hit the strike price (or below). If you get assigned the stock (meaning the price is at or below the strike price at option expiration) you will now be holding that position, possibly with a gain or loss depending on the premium you received and the current stock price. Once you hold the stock, you can sell covered calls, which means you have the responsibility to sell the stock to the call holder should the price of the stock reach the strike price of the new option by the expiration date.
In the options wheel, you are generating premiums by selling puts and calls. Many options wheel traders seek to avoid assignment and treat the covered call part of the wheel as a recovery strategy, not as the core income strategy.
In a strong uptrend, the wheel underperforms buying and holding stocks. But in choppier markets and downtrends, the wheel can outperform. It is obviously a much more active strategy than buy-and-hold passive index funds. In that way, it suits me, because I do love to be active with my money management.
There’s not a lot of evidence about how the wheel performs in comparison to buy-and-hold, but some say you can expect 12 to 18% annual returns targeting a delta (representing the probability that you get assigned) of 0.20 to 0.30, which is very conservative. Because you can also double dip by putting the cash you’re holding in case of assignment into a money market fund or other dividend-yielding investment, you can actually boost this by whatever the prevailing interest rate is (about 3.5% right now for Schwab’s main money market fund). By increasing the delta at which you can sell puts, you can increase the potential returns at the cost of possibly suffering large drawdowns in the case of corrections, crashes, or bear markets. A moderate wheel strategy selling puts and calls at 0.30 to 0.40 delta might produce a target annual return of 15 to 22%, on top of the yield you get on your cash (not when you’re assigned though!)
I’m combining wheeling with technical analysis (analyzing price, momentum, and volume charts for each ticker), light fundamental analysis (evaluating actual businesses with respect to their earnings, cash flow, revenue, and more), and macroeconomic analysis. The last is more for fun than for profit as I’ve found that it doesn’t help that much in choosing tickers that will go on to do well, although it did inform the large position in gold I established last year.
It’s useful to also gauge where we are in the stock market cycle, because that can help me decide whether to take on more or less risk when wheeling, or when doing any kind of trading. There are various models for this, but let’s use Michael Howell’s recently shared on an episode of the Forward Guidance podcast (extracted from the podcast transcript by Gemini):
| Season | Metaphor | Market Environment | Asset Performance |
| Rebound | Spring | Liquidity begins to rise after a crisis; central banks are easing. | Markets recover; early-cycle stocks perform well. |
| Calm | Summer | Liquidity is plentiful and stable; the economy is growing steadily. | Ideal for risk assets; “Goldilocks” environment. |
| Speculation | Autumn | Current Phase. Liquidity is inflecting lower. The real economy is accelerating and demanding more cash, leaving less for markets. | Volatility increases. Investors often chase “junk” or high-risk assets as a last hurrah. |
| Turbulence | Winter | Liquidity dries up; debt refinancing becomes difficult. | Very difficult for risk assets. High cash weightings are recommended. |
We are in the “Speculation” phase now, as anyone watching the semiconductor stocks moon would have already guessed. We have seen the real economy accelerate, with massive investment into data centers and all that entails (purchase of chips, constructing buildings, hiring plumbers and other tradesmen, arranging for adequate electricity supply). Cash is being drained from other sectors such as software, which seems right now like an also-ran in the dash for AI returns.
Howell suggests that it’s not time to exit the market entirely but instead a period to “pay back risk” that you’ve taken on before and prepare for a winter of Turbulence. That could be a tough period for an options wheel trader except that chop increases implied volatility which leads to higher options premiums. That reflects greater risk though so it’s not altogether a good thing. It does offer some opportunities though.
My plan is to maintain a conservative stance but not too conservative. I know that this Speculation phase could last months or years longer. That happened during the dotcom boom. In late 1996, Fed Chair Alan Greenspan used the phrase irrational exuberance to question whether rising asset values were driven by unwarranted investor enthusiasm rather than economic fundamentals. The stock market didn’t reach its ultimate peak until March of 2000. If we consider the introduction of ChatGPT to have launched this latest iteration of speculation in November of 2022, it could be that we’re reaching peak bubble now. But who knows if this one could run even longer? One more year? Two?