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The options wheel strategy: get passive crypto gains in two steps

The world of cryptocurrencies is exciting, but let's face it, actively trading and scalping the crypto markets can be nerve-wracking, especially for beginner traders. Fortunately, with the options wheel strategy, crypto traders can breathe a sigh of relief. The two-step options strategy allows active crypto options traders to step back and take a more passive approach thanks to its simplicity.

It's no wonder the wheel strategy is favored among both experienced options traders and newcomers to options strategies. Interested in adding this two-step option strategy to your trading arsenal? From explaining what the wheel strategy is to highlighting its pros and cons, here's everything you need to know when it comes to learning and mastering the options wheel strategy.

What is the options wheel strategy?

The wheel strategy is a two-step options strategy that's made up of two separate options strategies, namely the cash-secured put and the covered call. When used in tandem, it creates a powerful cyclical options strategy that's often used by traders to generate a steady flow of gains over time.

By writing put and call options contracts, traders will effectively capture gains from the premiums associated with these options, regardless of the price movement of the underlying asset. As such, you'll typically enjoy the full impact of the options wheel strategy in range-bound markets where prices are stuck trading in a set range.

Understanding calls, puts, and options premiums

Let's go deeper by understanding the two types of options involved:

  • Calls: Call contracts give the buyer the choice to buy a certain amount of cryptocurrency at a specific strike price by a certain expiry date. As the seller of a call option, you collect a premium for granting this buying right. If the price of the crypto asset goes above the strike price by expiry, you might be obligated to sell your crypto at the strike price.

  • Puts: Put contracts give the buyer the choice to sell a certain amount of cryptocurrency at a specific price by a certain expiry date. As the seller of a put option, you collect a premium for granting this selling right. If the price of the crypto asset goes below the strike price by expiry, you might be assigned and forced to buy the asset at the strike price.

With these terms in mind, let's now look at how a typical options wheel strategy operates.

Wheel strategy explained: how options wheel strategies work

Selling a cash-secured put

As mentioned earlier, the options wheel strategy is comprised of two key parts. The first step involves selling a cash-secured put, which credits you with options premiums. If the price falls below the strike price by expiry, you'll be assigned the crypto at the predetermined price using the funds you previously set aside. That's because the put contract in question is now in-the-money (ITM). This can be beneficial because you're acquiring the asset at a discounted price.

Selling a covered call

Owning the underlying asset now allows you to enter the second phase of the wheel strategy. Here, you can start selling covered calls. Covered calls grant buyers of your call contract the right to buy your crypto at a specific price at expiry. By selling this covered call, you're effectively collecting additional premium while agreeing to sell your underlying asset at the agreed price of the calls. It's important to remember that covered calls let you collect call option premiums but ultimately limit your potential gains if the price of the crypto asset rises significantly above the strike price of the written call contract.To further break down how the wheel strategy works, here's a step-by-step guide that highlights the experience of running the options wheel strategy for Ether.

Setting up the options wheel strategy with our step-by-step example

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Step

1

Choose an underlying crypto asset

2

Sell a cash-secured put option

Scenario if put expires out-of-the money (OTM): Continue to sell cash-secured puts and earn premiums.

Scenario if put expires ITM: Proceed to write covered calls with the underlying asset you now own.

3

Sell a covered call option

Scenario if put expires OTM: Continue to sell covered calls and earn premiums.

Scenario if put expires ITM: Pick another crypto asset and strike price to sell cash-secured puts at with your now freed-up funds.

Step 1: Choose an underlying crypto asset

While options contracts exist for all kinds of coins and tokens in the crypto space, a golden rule to follow is to only run the wheel for assets that you don't mind holding for the long haul. This is because market volatility could keep prices suppressed for indefinite periods of time, with you ending up going long and rendering your funds illiquid. That's why most option sellers recommend selecting a reputable cryptocurrency which you have the conviction to hold for the long run and are looking to build a position with at a discounted price.

Step 2: Sell a cash-secured put option

Imagine you want to own Ether at a discount. You can begin the options wheel strategy by selling a cash-secured put option for ETH. This means you're collecting a premium upfront while setting aside the equivalent amount of funds to cover the purchase of ETH at the strike price if you're assigned and forced to buy.

One interesting point to note is the choice of strike price. In an ideal scenario, you'd want to avoid getting assigned because ownership of ETH would tie up your liquidity. That's why you'll want to select a strike price that's below the current market price, but not so OTM that the put premiums collected seem negligible. Selecting the right strike price comes down to your personal risk tolerance and the preferred price at which you want to own ETH should you get assigned.

Scenario if put expires OTM

If ETH prices remain above the strike price of your cash-secured put by the expiry date, you'll have the freedom to repeat the entire cycle. This is because the OTM put option expires worthless and the funds you've set aside are now liquid again as they aren't tied down by any assignment obligations. You can then begin to sell cash-secured puts again with a new strike price and expiry date to collect another round of premiums.

Scenario if put expires ITM

Let's say the price of ETH goes down significantly by expiry. You'll then be assigned ETH at the predetermined strike price of the put you sold. While this does involve tying up the funds you set aside, it isn't necessarily bad news since you've essentially bought ETH at a discount.

Once you own the crypto asset, you can start selling covered calls. Covered calls give someone else the right to buy your crypto at a specific price by a certain date. You collect a premium for this, and if the price stays below the strike price by expiry, you keep the crypto and the premium. This allows you to potentially earn additional gains while you wait for the price to rise further.

Step 3: Sell a covered call option

Now, let's further explore what happens if scenario two from step two (see the table above) happens and the price of ETH dipped below your strike price. This would cause you to be assigned ETH at the predetermined price. Here's where the cyclical nature of the options wheel strategy comes into play as you now hold ETH. This fulfills your initial goal of acquiring ETH in your holdings, although it may not be at the exact price you'd hoped for. With this ETH now in your possession, you can start the second phase of the wheel by selling covered calls. By writing a call contract against your ETH holdings, you're pledging to sell your ETH at a predetermined strike price if ETH prices go above this level at expiry.

Scenario if call expires OTM

Since the call you've written expired OTM, the buyer of the call option has allowed it to expire worthless. This means they don't exercise their right to purchase your ETH at the predetermined price and you keep hold of your ETH. This allows you to continue selling calls against your ETH to generate a continuous stream of gains in the form of call premiums.

Scenario if call expires ITM

Covered calls expiring ITM will result in delivery of the ETH to the buyer of your covered call. Even though this may result in you missing out on any further potential price appreciation of ETH if it continues to climb after you sell it at the predetermined strike price, it does mean you now have freed up capital to once again execute the cash-secured put portion of the options wheel strategy.

Benefits of the options wheel strategy

  • Passive gains potential: By strategically selling cash-secured puts and covered calls, you can collect premiums regardless of whether the price of the underlying cryptocurrency goes up or down. This creates a cyclical stream of funds that can potentially grow your crypto holdings over time.

  • Relatively lower risk: Compared to actively trading crypto, the options wheel strategy involves lower upfront capital and focuses on capturing smaller, more frequent gains. By choosing strike prices strategically and managing risk effectively, you can potentially mitigate some of the volatility inherent in the crypto market.

  • Learning opportunities: While seemingly basic, running the options wheel strategy allows you to get started in the world of options trading in a controlled environment. By experiencing the mechanics of selling puts and calls, you gain valuable insights that can be applied to other more complex options strategies in the future that include spreads and multi-legged strategies.

Risks to consider with the options wheel strategy

  • Market volatility: The cryptocurrency market is notoriously volatile and sudden price swings can significantly impact your options positions. As such, there's always a chance of getting assigned crypto at a different price than intended.

  • Potential for losses: Gains are never guaranteed with any trading strategy. From unexpected market movements to miscalculations in strike price selection, the options wheel strategy could lead to losses, as with all forms of crypto trading strategies. Proper risk management and starting small are essential to help minimize these potential losses.

  • Understanding options greeks: While not essential for beginners, options greeks represent key metrics used to analyze options contracts and their behavior. Ranging from delta to theta, having a basic understanding of these concepts can help you make more informed decisions when implementing the options wheel strategy.

Final words and next steps

Overall, the options wheel strategy offers a beginner-friendly approach to potentially generating passive gains in the crypto market. By strategically selling cash-secured puts and covered calls, you can capitalize on small price movements and earn premiums regardless of whether the market goes up or down. However, it's crucial to remember that the crypto market is inherently volatile, and there's always a risk of unexpected price swings.

To learn more about where you can trade crypto options and execute options strategies, check out top crypto options platforms like OKX to get started with crypto options. Additionally, you can read up on hedging strategies with our delta neutral options strategy guide.

FAQs

How much money can I make with the options wheel strategy?

The potential gains from the options wheel strategy depend on several factors, including the chosen cryptocurrency, strike prices, premiums earned, and market volatility. Overall, there's no guaranteed amount, and it's important to have realistic expectations when executing this options strategy.

Is the options wheel strategy safe?

The options wheel strategy aims to reduce risk compared to actively trading crypto. However, there's always inherent risk in any strategy. Proper risk management, understanding the mechanics involved, and starting small are crucial for mitigating potential losses.

What happens if the price of the cryptocurrency falls significantly when running the wheel strategy?

If the price falls below your put option's strike price, you'll get assigned and be forced to buy the cryptocurrency at that price. This could lead to a loss if the price doesn't recover quickly. However, you can potentially mitigate this risk by choosing strike prices strategically.

Can I use the options wheel strategy with other assets besides cryptocurrencies?

Yes, the same strategy can be applied to stocks and other assets that have options contracts available. However, the mechanics and risk profile might differ depending on the underlying asset's volatility and liquidity.

Is the options wheel strategy suitable for everyone?

The options wheel strategy is generally considered beginner-friendly but still involves options trading. This makes it unsuitable for those with a very low risk tolerance or limited understanding of crypto markets.

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