The Enhanced Wheel Strategy (Using Ratio Spreads)

The Wheel Strategy is a very popular Options trading strategy.

That’s because it is very simple and straightforward in its execution.

You start off with a Cash Secured Put to get into a Long stock position.

And you clear out your stock position with a Covered Call.

However, at times, the premium received from selling the Cash Secured Put and Covered Call may not be that juicy.

What if there was a way to enhance the profits you receive from trading the Wheel Strategy?

I call this the Enhanced Wheel Strategy.

The Traditional Wheel Strategy

If you’re new to trading the Wheel Strategy, then here’s a quick overview of what it is.

To initiate the traditional Wheel Strategy, you start off by selling a Cash Secured Put.

You sell it at the strike price at which you don’t mind getting Long 100 shares if you get assigned.

If you don’t get assigned, you simply sell the Cash Secured Put again until you finally get assigned the 100 shares.

Once you’re assigned, the next step would be to sell a Covered Call.

There are two ways to sell the Covered Call:

• Sell the same strike price at where you sold the Cash Secured Put. So if you sold the Cash Secured Put at the 100 strike price, then you would sell the Covered Call with the 100 strike price as well.
• Sell the strike price above where you sold the Cash Secured Put. In this case, would sell the Covered Call above the 100 strike price.

Both methods have pros and cons.

The pros of selling the same strike are that your Covered Call premium would be higher because it’s closer to where the current market price is.

The cons of it are that you don’t get any capital gains from the underlying stock because you entered and exited at the same price.

On the other hand, the pros of selling a higher strike are you get the capital gains on top of the premiums for selling the Cash Secured Put and Covered Call.

The cons of selling the higher strike price are that you may have to wait for the market to go up before you’re able to sell a Covered Call.

Once you’re assigned on the Covered Call and your 100 shares get called away, you reset the Wheel Strategy again.

The Enhanced Wheel Strategy

The Enhanced Wheel Strategy has the same cycle as the traditional Wheel Strategy.

The difference is instead of using a Cash Secured Put on entry, you use a Put Ratio Spread.

A Put Ratio Spread is where you sell a Put, and you use the premium you received to purchase a Put Spread (aka Bear Put Spread).

So for example, you sell the 100 strike Put and receive $2.00 in credit.

Then you purchase a 105/100 Put Spread for $1.50.

This leaves you an overall credit of $0.50.

If the underlying stock closes below $100 at expiration, you will make $5.00 on the Put Spread and still keep the $0.50 you receive for selling the Put Ratio Spread.

Your overall profit would be $550 per Put Ratio Spread.

And instead of using a Covered Call to exit your 100 shares, you use a Call Ratio Spread.

The Call Ratio Spread is similar to the Put Ratio Spread but uses Call Options instead.

By using ratio spreads, we can increase the profit made when we get assigned.

That’s because with the ratio spreads, there is the element of the embedded debit spread.

With this debit spread, the profits can be increased compared to simply selling a Put/Call Option for their premiums.

The Traditional Wheel Strategy VS. The Enhanced Wheel Strategy

Here is a comparison of trading the traditional Wheel Strategy versus the Enhanced Wheel Strategy on Starbucks (Ticker: SBUX).

To make a fair comparison, both the traditional Wheel Strategy and the Enhanced Wheel Strategy will have the Short Put strike at the same price of $77.50.

For the traditional Wheel Strategy, we received $1.98 in credit for selling the Cash Secured Put.

For the Enhanced Wheel Strategy, we used the credit to purchase the 82.5/77.5 Bear Put Spread leaving us an overall credit of $0.24.

To next step is to identify all the scenarios that can happen and see which one does better for each of them.

Scenario 1: SBUX is above $82.50 at expiration

If SBUX is above $82.50 at expiration, then both the Cash Secured Put and Put Ratio Spread will expire worthless.

So the profit for both strategies is simply the credit received upon entry.

For the traditional Wheel Strategy, since the credit received is $1.98, then the profit is $198.

As for the Enhanced Wheel Strategy, since the credit received is $0.24, then the profit is just $24.

In this scenario, the traditional Wheel Strategy would have been better.

Scenario 2: SBUX is between $82.50 and $77.50 at expiration.

For this scenario, the profit for the traditional Wheel Strategy is the same as in scenario 1 since SBUX expired above the Cash Secured Put strike price.

So the profit for the traditional Wheel Strategy is also $198.

For the Enhanced Wheel Strategy, the profit depends on exactly where the price of SBUX is at expiration.

That’s because the price has entered into the Put Spread of the Put Ratio Spread, and this is where the profit starts to increase.

If SBUX is at $80.25 at expiration, then the profit would be calculated as follows:

Profit = [$0.24 + ($82.50 – $80.25)] x 100 shares = $199

If SBUX is at $78.50 at expiration, then the profit would be calculated as follows:

Profit = [$0.24 + ($82.50 – $78.50)] x 100 shares = $424

In the first case, both the traditional Wheel Strategy and Enhanced Wheel Strategy made roughly the same amount.

But in the second case, the Enhanced Wheel Strategy made more than double what the traditional Wheel Strategy made.

As you can see, the Enhanced Wheel Strategy rewards you more if the stock drops.

Scenario 3: SBUX is below $77.50 at expiration.

In this scenario, both strategies will be assigned the shares since SBUX closed below both the Short Put strike at expiration.

However, the profit made for the traditional Wheel Strategy still remains at $198.

Whereas the profit made for the Enhanced Wheel Strategy is $524 because it made the full profit on the embedded Bear Put Spread, plus the credit received for selling the Put Ratio Spread.

So if we were to calculate the breakeven prices of the 100 shares, the breakeven price for the traditional Wheel Strategy would be:

Breakeven Price = $77.50 – $1.98 = $75.52

And the breakeven price for the Enhanced Wheel Strategy would be:

Breakeven Price = $77.50 – [$0.24 + ($82.50 – $77.50)]  = $72.26

So the breakeven price is much lower when we use the Put Ratio Spread.

Pros & Cons of Both Strategies

Here are the pros of both strategies.

Traditional Wheel Strategy:

• Consistent premium collection. Regardless of where the market goes, you already know how much you will be getting in premium on entry.
• Simpler to execute. There’s only just one Option to sell so it’s very easy to execute it.
• You make more on the Cash Secured Put when the market goes up compared to the Put Ratio Spread in the Enhanced Wheel Strategy.
• You also make more on the Covered Call compared to the Covered Call Ratio Spread if the market doesn’t go up.

Enhanced Wheel Strategy:

• Bigger maximum profit potential compared to the traditional Wheel Strategy. If both Put Ratio Spread and Covered Call Ratio Spread are assigned, they will achieve maximum profit.
• More protection on the downside. That’s because the Put Ratio Spread will make more as the underlying stock drops.
• Higher profits on the Put Ratio Spread lead to a lower breakeven price when you get assigned compared to the Cash Secured Put.
• And that leads to making it easier to exit the stock position because of the lower breakeven price.

Here are the cons of both strategies:

Traditional Wheel Strategy:

• Lesser profits than the Enhanced Wheel Strategy if assigned on both Cash Secured Put and Covered Call.
• Lesser downside protection for the Cash Secured Put compared to the Put Ratio Spread.
• Worser breakeven price when assigned on the shares.
• The stock has to move up more in order to exit for a profit as the breakeven price is higher than the Enhanced Wheel Strategy.

Enhanced Wheel Strategy:

• Inconsistent profits. The profits aren’t predictable since it’s dependent on where the stock settles at expiration.
• More complex decisions to make because the Ratio Spreads has more legs in its construction.
• The Put Ratio Spread won’t make much if the underlying stock goes up.
• The Covered Call Ratio Spread won’t make much if the underlying stock goes down.

So which is better for you?

It all comes down to your style of trading.

If you’re more focused on profits and want simplicity in trade execution, then the traditional Wheel Strategy would be more suitable for you.

But if you’re more afraid of the market crashing and want to make more if the market tanks, then the Enhanced Wheel Strategy would be more suitable for you.