How to Find Quality Stocks for the Wheel Strategy

Learn how to find quality stocks for the Wheel Strategy using fundamental analysis and options screening to evaluate potential cash-secured put candidates.

One of the most important choices when using the Wheel Strategy is selecting the underlying stock. The way in which you sell a cash-secured put and possibly enter a covered call position is fairly simple. The more difficult issue is deciding which companies should be included in that process to begin with. A stock may appear to offer an attractive option premium, have high implied volatility, or seem to provide an appealing annualized return on investment, yet it could still be a bad choice if the business behind it has problems that you wouldn't want to endure during a major decline. Which is why stock selection should not start and finish with the options chain. A more organized method involves looking at the company first and then at the options market. To put it simply, the process can be seen as a quality business → fundamental screening → options screening → identification of a potential Wheel candidate . This approach doesn't get rid of risk and is unable to predict what a stock will do in the future. It merely provides a more disciplined way of distinguishing between companies that you might be comfortable owning and option contracts that just happen to look attractive at a given time. The way that the Wheel works supports this idea. According to the Options Industry Council, the strategy involves a cycle which starts by selling a cash-secured put on a share of a stock that the investor is willing to own. In the event that assignment takes place, the shares are obtained and covered calls can then be sold against them. This shows that the underlying stock is not merely a figure attached to an option contract; it might in fact be the asset that you end up holding. Why High Option Premium Isn't Enough A high option premium naturally draws attention to itself. It might be tempting to think that if one stock has a much higher premium than another for the same expiration period, then the higher premium must indicate a better trading opportunity. However, the premium is payment for assuming risk, not a free amount given for waiting. The way options are priced takes into account a number of factors, such as the stock price, the strike price, the time until expiration, and implied volatility. It is therefore possible for a higher premium to be associated with a greater expected price movement or with more uncertainty about the underlying security. Implied volatility is especially relevant in this case since it shows the market's expectations regarding future price movements, as these are reflected in option prices. According to the Options Industry Council, greater implied volatility leads to higher option premiums and also indicates expectations of bigger price movements. This makes for an important point: although high implied volatility can make a cash-secured put appear more attractive from the point of view of income, it at the same time means that the market expects greater movement. Let us imagine two stocks. Company A is financially sound,