The best stocks for your 2024 wheel strategy
The so-called wheel strategy is a popular technique used by options traders looking to earn a steady income with manageable risk.
But here's the rub: while the strategy itself isn't rocket science, picking the right stocks can be a real head-scratcher.
You may be wondering which companies are the perfect fit for your wheel—the ones that churn out premiums without exposing you to unnecessary risk.
It's tempting to chase after stocks with sky-high implied volatility or dividends that seem too good to be true. However, diving in without doing your homework can leave you holding the bag.
That's why we've put together this guide to help you find the best stocks for the wheel strategy. We'll break down the key factors to consider, look at some top contenders, and give you the tools to make informed decisions.
What is the wheel strategy?
Options trading can be tricky, but the wheel Strategy offers a straightforward approach that appeals to many options traders. Here's how it works in three steps:
- Sell cash-secured puts on a stock you want to own;
- If you're assigned, buy the stock;
- Sell covered calls on your new shares.
The wheel strategy helps you generate income whether stock prices go up, down, or stay the same. That lowers your risk, which is why so many investors love the Wheel Strategy.
The catch?
It can limit your profits if the stock price skyrockets, and there's a chance you'll end up with shares of a declining company. The strategy also requires active management—it's not a "set it and forget it" method.
How to choose the right stocks for your wheel strategy
It goes without saying that the linchpin of a successful wheel strategy is picking the right stock. Here's what you need to consider:
- Stability: Choose blue-chip companies like Apple (AAPL) or Microsoft (MSFT). Their stable prices and strong fundamentals reduce the risk if you're assigned shares;
- Dividend yield: Aim for stocks with a 3-4% dividend yield, like Coca-Cola (KO) or Verizon (VZ). Dividends provide an extra income stream while you wait to sell covered calls;
- Liquidity: Stocks with high trading volume and tight bid-ask spreads ensure smoother trade execution. This helps you enter and exit positions easily and consistently collect premiums.
- Diversification: Diversify your bets across different sectors to manage risk. This protects your portfolio from downturns in any single industry;
- Position sizing and volatility: Balance low-beta stocks (stocks that are less volatile than the market) with some higher volatility stocks for larger premiums. Use position sizing to avoid overcommitting to any one stock.
When it comes to options trading, it can sometimes feel like you’re biting off more than you can chew.
That’s why we've done the legwork to find the best stocks for your wheel strategy this year. From tech giants to steady dividend payers, we've got options for different risk appetites.
Best blue-chip stocks for the wheel strategy in 2024
Apple (AAPL)
Apple is an excellent choice for beginner options traders looking to try the wheel strategy. As one of the world’s largest companies, it offers stability and high liquidity, making it easier to trade. This typically allows for buying and selling options with minimal price differences.
Microsoft (MSFT)
Microsoft is another tech giant well-suited for the wheel strategy. Its stock is relatively stable due to the company’s size and strong financial health. With excellent options liquidity, it’s one of the best blue-chip stocks for options trading.
Coca-Cola (KO)
Coca-Cola offers a dividend yield of approximately 3.02% as of October 2024, providing a solid safety net if the stock price falls below your put option strike price. This allows you to hold a stable, income-generating stock while continuing to earn dividends. With its stable business model and lower volatility, Coca-Cola is a stable stock for covered calls.
Verizon (VZ)
Verizon offers an even higher dividend yield of around 6.84% as of October 2024. While the stock has been on the rise since early 2023, it’s important to stay mindful of challenges in the telecom industry. Despite this, its stability and high yield make it one of the best stocks for cash-secured puts.
Lockheed Martin (LMT)
For those seeking greater stability, Lockheed Martin stands out because the lion's share of its income comes from government contracts. With a beta of around 0.67, it’s less volatile than the average stock, making it an attractive option for those who prefer lower risk.
Best high dividend stocks for the wheel strategy
Brookfield Infrastructure Partners (BIP)
If you're new to options trading and looking for more stability, consider Brookfield Infrastructure Partners. This stock boasts a strong yield of 3.62% and lower volatility compared to the broader stock market. That makes the company one of the best stocks for income generation with options.
Kimberly-Clark (KMB)
Kimberly-Clark is another excellent choice for beginner options traders, offering low volatility and reliable dividends. With a current yield of 3.44% and a history of increasing dividends for 52 consecutive years, the stock provides the income and stability essential for the wheel strategy.
Gilead Sciences (GILD)
Gilead Sciences is another excellent option for traders seeking higher income while hedging their positions. Compared to other well-known biotech companies, it offers a strong 3.57% dividend yield with reasonable volatility, making it a safer choice than stocks without a yield.
Best ETFs for the wheel strategy
SPY (S&P 500 Index Fund)
SPY—the biggest ETF tracking the S&P 500 index by capitalization—covers a wide array of the 500 largest U.S. companies, giving you growth and stability. Its broad market exposure and high liquidity make it a staple for the wheel strategy.
Invesco QQQ (QQQ)
If you're keen on tech stocks, QQQ is worth considering. It tracks the Nasdaq-100, focusing on large-cap tech companies. QQQ not only offers growth potential but also provides opportunities for generating income through options, thanks to its higher volatility.
Implied Volatility (IV) and the wheel strategy
Higher volatility is not necessarily a bad thing for the wheel strategy as long as you adjust accordingly. Here’s a primer on using the wheel strategy during periods of high implied volatility (IV):
Strike price selection: Opt for strike prices that are further out-of-the-money (OTM). This lowers the risk of your options being exercised, though it might reduce your premium earnings;
Expiration management: Go for shorter expiration periods. This allows you to take advantage of the rapid time decay linked to high volatility, increasing your potential premium collection;
Reduce position size: Cut down on the number of contracts you trade. This reduces the added risk associated with high IV and keeps your overall exposure manageable;
Selecting lower volatility stocks: Concentrate on stocks or ETFs with lower volatility. This strategy can shield your portfolio from significant market fluctuations.
5 common mistakes to avoid in your wheel strategy
Although the wheel strategy is a less risky trading technique than other options trading strategies, it has its own risks. Here are five common pitfalls that beginner options traders may encounter:
- All eggs in one basket: If you trade only one sector and that one sector takes a hit, your entire wheel strategy could fall apart. Spread your bets across different industries to stay afloat during sector-specific downturns;
- Too big premiums: It might be tempting to go after stocks with the juiciest premiums, but these often come with higher risk. While the returns may be better in the short term, you could eventually find yourself holding the bag. For a more sustainable approach, stick to moderate premiums;
- Too high dividends: While dividends-yielding stocks can boost your returns, don't let them be your sole focus—especially one with tempting higher dividends. That's because extremely high yields can signal potential problems with the company. Remember, a sustainable 3-4% yield often beats an unsustainable 10% yield in the long run;
- Not enough liquidity: Make sure the stocks you trade have sufficient liquidity to allow easy entry and exit from your positions. Low liquidity can lead to wider bid-ask spreads, making it difficult to execute trades at favorable prices and potentially eroding your profits;
- A set-and-forget mentality: Unlike buy-and-hold investing, the wheel strategy needs active management. For optimal results, regularly review and adjust your positions based on market changes.
Frequently Asked Questions (FAQs)
What is a good stock for the wheel strategy?
A solid stock for the wheel strategy is one that has strong fundamentals, consistent performance, and decent options liquidity. Companies like Coca-Cola (KO) or Procter & Gamble (PG) often work well because they are stable and tend to have good option premiums.
How do you choose stocks for the wheel strategy?
Choosing stocks for the wheel strategy involves several steps. Look for stocks with a history of price stability and moderate volatility. Focus on those that offer options with good premiums. Also, consider companies that you wouldn’t mind owning, as you might end up buying the shares through the covered call process.
Is the wheel strategy suitable for beginners?
The wheel strategy can be suitable for beginners, but it requires a solid understanding of options trading. Beginners should familiarize themselves with how options work and manage risks effectively. Starting with well-established companies can make the learning curve more manageable.
Can dividend stocks be used in the wheel strategy?
Yes, dividend stocks can work well in the wheel strategy. Not only do you earn premium income from selling options, but you also benefit from dividend payments while holding the stock. This combination can enhance overall returns.
What risks come with the wheel strategy?
The wheel strategy carries several risks. The primary concern is the potential for significant losses if the stock price drops sharply after being assigned. Additionally, there’s the risk of missing out on gains if the stock price rises significantly after selling a covered call. Understanding these risks is crucial for effective risk management.