Should A Trader Do The Wheel on DIA To Work Her Way Out Of A Small Loss After Having Its Puts Assigned?

Income options traders sometimes have stock and ETF puts assigned after the stock falls below the puts strike price. Then they do the wheel. They sell covered calls on the equity to recover the loss.

By Donald E. L. Johnson

Cautious Speculator

• Sell puts on DIA at a $354 strike.

• The DIA puts are assigned and sold for $354 to the seller of the puts.

• During the next trading session, DIA is trading for $346.11.

• The trader sells covered calls on $354 strike calls and collects the monthly dividend and the weekly dividend.

Now and then puts are assigned and the stock or ETF involved is sold to the trader who sold the puts options. Then the trader has to decide whether to sell the stock, take a loss and move on, or do a “wheel” trade.

For example, say a trader sold DIA 2.11.22 expiration puts at the $354 strike. On Friday, the stock closed below the $354 strike price and the shares (100 per option contract) were assigned (sold) to the puts trader. The stock now is at about $346.11, or down 2.23% from the stock’s purchase price. To breakeven at $354, DIA has to rally 2.28% back to $354. The trader waits until mid-day Monday to give DIA time to rally from its opening price drop.

But, in this market, who knows whether the stock will rally or drop 5%, 10%, 20% or more? Support is at about $332 on this point and figure chart. Resistance is at about $368. This chart is an example of a failed bullish breakout, which is bearish.

Do you take the risk of a further drop in the market? That would mean it would take longer to wait for a rally and to sell call options enough times to bring the net debit to breakeven.

Every trader has her own risk tolerance and risk aversion comfort levels and financial situation to consider in making a trading decision.

The trader could sell DIA, take the $2.23% loss and move on to another trade. She wouldn’t buy DIA again for at least 31 days so that the tax loss would be recognized by the IRS. She wouldn’t create a wash sale by buying DIA again until she was out of the stock for at least 30 days.

In a wheel trade, she would sell DIA 2.18.22 $354 strike covered calls for, say, $0.73. If the stock pops above the strike before Friday’s close, her DIA calls would be exercised and sold to the owner of the calls. She would break even on DIA and keep the premiums and dividends she had collected since DIA was put to her.

If DIA continued to sink in the face of the Russia versus Ukraine situation and rising interest rates, the call options would expire worthless. The DIA owner would keep the premium on this week’s sale of covered calls. The next Monday or later, she would sell DIA weekly covered calls at $354 or lower strikes. She would do this every week or month until DIA popped and it was called or she just decided to sell DIA.

She could sell covered calls for $0.73 a share for 10 weeks without having the stock drop further and without having the calls exercised. Then she would more than break even after collecting two or three months of dividends in the process. Or the stock could drop to the support price or lower and it would take longer to wheel out of the losing trade.

Should DIA pop and be called at a strike under $354 sometime down the road, she would accept the assignment, lose the shares and take a loss at or below whatever her net debit was at the time of the trade. The net debit is the price of the stock less collected dividends and puts and call options premiums collected since the first DIA puts or calls options trade.

After having DIA called, she would decide whether to continue trading the DIA wheel by selling DIA puts that expired more than 30 days after it was called.

While I seldom have puts assigned because I sell low delta puts that reduce my risks of assignments, it has happened. I may do a few wheel trades today or later this week.

I’ve used the wheel strategy to breakeven or more than breakeven on the trades. It can take a few weeks or a few months, depending on what happens to the price of the stock or ETF.

Question: Are you in or considering a wheel options trade? We can discuss it in comments.

LINKs:

Home Page. See previous articles on other stocks.

Calls vs Puts Options: What’s the Difference?

A video on how to place options trades on Think or Swim.

Beware

Like all investing, trading stocks and options is risky. If you can’t sleep with market risks, you might want to let someone else do your trading. Consider an option trading ETF like XYLD, which I own. I also trade its calls and puts. I’m an active private speculator who trades covered calls and sells puts on stocks for my accounts. I am not a professional analyst nor a financial advisor. I don't take and won't take responsibility for how other people trade. This article is for educational purposes only. It is not advice. The data presented looked accurate at publication time except for intra-day fluctuations, but I can’t guarantee the accuracy. Traders should do their due diligence. I reserve the right to trade any of the listed stocks and options at any time. I own and/or have options positions on DIA.

@realDonJohnson. I’m active on twitter where I tweet about trading and other things and link to tweets about stocks.

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