Do you know how to trade options to maximise returns from S&P 500 ETF?
We'll show you the Wheel Strategy to multiply profits from S&P 500 index.
- Why Invest in S&P 500 ETF?
- What Is the Wheel Strategy?
- Which S&P 500 ETF Is Most Suitable for the Wheel Strategy?
- 3 Steps to the Wheel Strategy
- How to Set the Strike Prices of Put and Call?
- Expected Returns of Trading the Wheel Strategy With SPY
- Differences Between Holding SPY ETF and the Wheel Strategy
- Best Value Stocks for the Wheel Strategy
Why Invest in S&P 500 ETF?
Most experienced traders recognise Standard & Poor's 500 index as the most iconic index fund in the world. It tracks the performance of 500 most profitable companies in the US stock market.
Companies included in the S&P 500 make up around 80% of the total market capitalisation, is widely regarded as the best gauge of large-cap U.S. equities, and a favourite among passive investors.
Most people expect an annual return of 9% from buying and holding ETFs that track the S&P 500 index.
Some of the most dominant companies in the world, such as Apple, Google, Facebook, Netflix, Disney are included in the index. Tesla was also included in the S&P 500 index for the first time in December last year.
Investing in an S&P 500 ETF is a diversified way of purchasing stocks from all these companies at the same time.
What Is the Wheel Strategy?
An expert options trader knows that selling options is most profitable when the underlying doesn't fluctuate a lot, which makes the Wheel Strategy perfect for S&P 500 ETFs that are well diversified and prices don't change suddenly.
Which S&P 500 ETF Is Most Suitable for the Wheel Strategy?
There are 3 popular ETFs that track the S&P 500, which are SPY, IVV and VOO. The 3 ETFs have different tracking accuracies, different management fees, so you might wonder which one is most suitable for the Wheel Strategy.
Since the Wheel trading strategy uses options to boost the returns on investing the underlying for the long-term, we choose the best ETF by the volume of options traded for each ETF.
|S&P 500 ETF||Daily options volume|
By comparing the options volume for each of the 3 ETFs, we can tell SPY has exponentially more options liquidity than the other 2. So we will choose SPY is the symbol for trading the Wheel Strategy.
3 Steps to the Wheel Strategy
The Wheel Strategy is a sequences of repeatable steps that we can use to combine selling options with holding stocks to buy low and sell high the SPY ETF.
The 3 steps of the SPY options strategy depend on the number of shares you hold:
- Sell a Cash-Secured Put when holding 0 shares
- Sell a Strangle (a Put and a Call) when holding 100 shares
- Sell 2 Call options when holding 200 shares
1. Sell a Cash-Secured Put When Holding 0 Shares
When we do not own any SPY stock, we can sell a Cash-Secured Put that expires in 30 days.
If SPY does not drop below the strike price after 30 days, we will collect all the premium from the trade.
If SPY price drops below the strike price, we will be assigned 100 shares of SPY at a discount. Then we move on to the next step.
2. Sell a Strangle When Holding 100 Shares
Now we own 100 shares, we can sell a Strangle that expires in 30 days, which is a combination of a Cash-Secured Put and a Covered Call.
If the SPY price stays within the 2 strike prices after 30 days, we collect all the premium from selling options.
If the SPY rises beyond the Call strike, we will forced to sell the 100 shares at a high price. Then we move back to step 1.
If the SPY price drops below the Put strike, we get to purchase another 100 shares at an even lower price. Then we move forward to step 3.
3. Sell 2 Covered Call Options When Holding 200 Shares
Now we own 200 shares of SPY ETF, we can sell 2 Covered Call options at the same time to earn twice the amount of premium.
If the ETF price doesn't rise after 30 days, we collect all the premium.
If the SPY price increases beyond the Call strike, we will sell 200 shares at a high price and move back to step 1.
How to Set the Strike Prices of Put and Call?
If we look at the price history of SPY, we can see the ETF price rarely falls beyond the Bollinger Bands. So we can use the Bollinger Bands to set the strike prices for selling Puts and Calls.
The upper and lower bounds of the SPY Bollinger Bands are currently $376 and $394, so we can use these as the strike prices for selling Puts and Calls.
Another quick way to set the Strangle prices is to use the Options Scanner to find the prices at 0.20 delta.
|Symbol||Last||Strangle details||Strangle BP||Strangle ROC|
The 0.20 delta Strangle suggested by the options scanner:
- Short $396 Call and short $361 Put
- If you don't own any SPY shares, you need $4313 buying power for a 10.5% return on capital
Expected Returns of Trading the Wheel Strategy With SPY
We can use step 2 to estimate the wheel options strategy returns with SPY. If we assume the fluctuations of SPY rarely exceed our Bollinger Bands, the premium collected from $376 Put and $394 Call is around $1200 per month.
Since we set aside $77,000 cash to purchase 200 shares of SPY, the monthly return from the premium is 1.6%, which is around 19% per year.
Differences Between Holding SPY ETF and the Wheel Strategy
If buying and holding shares of SPY can expect 9% average return a year, then we can add 19% more from the premium of the Wheel Strategy, tripling our annual returns on investing in SPY.
|Strategies||Holding SPY ETF||Wheel strategy|
Best Value Stocks for the Wheel Strategy
We can use the Bullish Value Stocks to find a list of financially strong companies that are currently undervalued.
The list shows both Shopify and Facebook are extremely undervalued right now. They are great companies with profitable software platforms and huge competitive advantages:
- Both companies have close to 100% Upside from their respective Fair Values.
- Plus the Long Signal Days indicator shows both stocks bottomed out last week.
So we can trade Cash Secured Put options to SHOP and FB to earn income from the premium while anticipating an upward rebound.
If the stock price drops, we have a chance to buy 100 shares of Shopify at $475.60, around 21% off the original price.
Meta's market price is currently around $200, a short Cash Secured Put at 0.20 delta, $175, that expires next month will receive $3.60 in premium per share.
If the stock price drops, we have an opportunity to buy 100 shares of FB at $171.40, around 14% off the original price.
Both Cash Secured Put trades give us the opportunities to buy stocks at a discount. Apart from the differences in discounts, we also notice the differences in cash buying power required for the two trades.
|Stocks||Discount on stock||Cash needed|
The SHOP trade requires $47,560 of cash to secure each Put option contract. While the FB Cash Secured Put option requires $17,140 of buying power per contract.
Now it's your turn to experiment the Wheel Strategy on ETF or low IV stocks. If you would like me to analyse other popular symbols, please leave a message below.