I’m undertaking a 1000-day reinvention project, blogging here daily to track my progress. In Monday Money, I write about money management.
Since I started the options wheel as my main approach to trading, I’ve mostly traded options for individual stocks, with some ETFs here and there. Last week, I decided to move towards mainly trading options on ETFs, as a way of reducing risk.
The biggest risk of the options wheel is getting assigned on a short put at a price far below my cost basis (the strike price less any options premium received). While getting assigned to buy a particular ticker is part of the options wheel — and leads to immediately selling covered calls if you can do so without having your shares called away at a loss — this is also the source of potential very large drawdowns. If the underlying stock or ETF never returns to a price that provides a profit to you (either through its appreciation or through selling of calls) you lose money on that particular sequence of trades. In some cases, this can be a very large amount relative to premiums earned.
In some cases, individual stocks can go to zero!
It’s why some people say the options wheel is “picking up pennies in front of a steamroller.”
Individual stocks are generally more volatile than ETFs (except, of course, for certain specialized ETFs such as leveraged 2x or 3x versions). An individual stock’s volatility can be decomposed into ticker-specific risk (e.g., what happens when there’s a bad earnings report), sector-specific risk (e.g., what happens when everybody rotates en masse away from semiconductors), and general market risk (e.g., what happens when investors and traders sell off all stocks indiscriminately). ETFs don’t have ticker-specific risk.
Selling puts on ETFs instead of individual equities could mean fewer disasters, less variability in my returns, and more reliable recovery after assignment. I hope I’ll see better risk-adjusted returns across the whole portfolio.
I expect that individual premiums relative to the exposure taken on will be lower generally speaking than if I sold puts on individual stocks. But I hope this will be more than compensated for via superior overall returns. And I expect that this will provide a more peaceful experience too, as I won’t wake up to bad news about one particular company that I hold a short put on!