"How do I choose a strike?" is probably the most common question new Wheel traders ask. Two answers do the rounds: pick a delta, or pick a price you'd be happy to pay. I use both, but not equally.
Start with the price, not the premium
If you sell a put and are assigned, you buy 100 shares at the strike. So the first question isn't "what pays best?", it's:
Would I be comfortable owning this company at this price, if the stock keeps falling after I buy it?
A simple example. A stock trades at $50 and I'm looking at the $45 put for $1.20. If I'm assigned, my effective price is $43.80 ($45 minus the $1.20 premium). That's only worth considering if I'd genuinely be happy holding the shares at $45, including the scenario where they drop to $38 the following week.
If the answer is no, a bigger premium doesn't fix it. It usually just means the market sees more risk.
On a $20,000 account where I cap each stock at about 10%, that's $2,000, which means a put with a strike of around $20 or under. The position limit narrows the choice before delta comes into it.
Where delta fits
Delta estimates how much an option's price moves for a $1 move in the share price. For puts, traders often use the absolute value as a rough guide to the market's pricing of the chance of finishing in the money. A 0.20 delta put is often described as roughly a 20% chance. It isn't a promise, and it changes as the share price, time and volatility change.
I find delta most useful for comparing strikes on the same stock side by side, and as a cross-check on a strike I've already picked for other reasons.
The same delta can sit very far apart
This answers a question I see a lot: "is 0.20 delta too conservative on a volatile stock?"
Here are two stocks, both at $50, with illustrative round numbers (not real quotes):
| Steady stock | Volatile stock | |
|---|---|---|
| Strike at about 0.20 delta | about $46 | about $40 |
| Distance below the share price | about 8% | about 20% |
The delta is the same, but the strike is in a very different place. The volatile stock's options are priced for bigger moves, so the same delta lands much further away, and it pays differently too.
That's why I don't treat "0.20" as a rule. After checking delta I ask: what is this strike in dollars and in percent, and would I own the company there?
What delta can't tell you
- A sudden gap down on earnings or bad news
- Whether the company's business is sound
- Whether the cash it ties up is a sensible share of your account
That's why delta is one input in my decision, not the decision.
I research the company first, then look at strikes I'd be comfortable being assigned at. I check delta as a cross-check rather than a target, I look at the strike in percent as well as dollars, and I make sure the cash it secures fits within my position limit.
A quick check before I sell
- Would I be comfortable owning this stock at the strike?
- Is the cash it secures within my position limit? (My cash planner helps with this.)
- Is there an earnings date before expiry?
- Does the premium justify the capital and the risk?
- If the stock fell sharply, what would I do? (See roll or take assignment.)
For more on how I think about this, see the cash-secured puts guide.
Educational content only. This article describes how I think about the Wheel. It isn't personal advice or a recommendation to buy or sell anything. Figures are illustrative and exclude fees and tax.
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