Backtest Basics: How to set up the Wheel strategy

The Wheel is when one of your short puts or short calls finishes in the money.  After you get "put stock" or get stock "called from you" and you start a new strategy based on the long stock or short stock position. For more general options instruction, go to The Options Industry Council site here.

For example, if you are trading a short naked put strategy, and the stock price expires below the strike, you will end up with a long stock position. One Wheel strategy is to sell a call on that position until you are called away, then the process starts over again with selling a naked put. Another Wheel strategy starts with selling a naked call, and if you get stock called away, selling a covered short put against the short stock.

Yet another Wheel strategy is a Covered Combo keeping any stock put to the strategy and selling a call against the new stock. In other words, the strategy is long stock, short call, short put, and if the put ends up in-the-money, sell a call against the new long stock (in addition to the short call against the original stock). I will show here how to set up the Covered Combo Wheel strategy in the ORATS Backtester.

We are looking at this strategy at the request of a client. Please understand that we are not recommending this or any other strategy, although we are a Registered Investment Advisor. You can see the disclosures here. The Covered Combo Wheel strategy is especially risky strategy because the strategy is short a put and long stock, a double whammy if the stock goes down. 

The ORATS backtester has a strategy called Covered Combo, but not a Covered Combo Wheel strategy. There will be a little work to do identifying the dates we get put stock and running an additional strategy. This additional strategy will be a buywrite. The new buywrite strategy will be combined with the covered combo to get the results of the Covered Combo Wheel.

Here's how to do the Covered Combo Wheel (buy stock, sell put, sell call plus write call against put stock) in the backtester:

• Select Covered Combo in the strategy dropdown menu. You will notice that the Strike Selection is short 30 delta call and short 30 delta put.

• Run the strategy by clicking Submit.

• Click on the link of the strategy and hit the button in the top right Download. This link will explain how to download trades.

• Open the downloaded zip file and open the Strategy Outputs folder. Open the StrategyTrades. This is how we will identify when we get put the stock.

• We have some formula work or manual work to do in Excel to identify the dates when we get put the stock.

• Match up all the dates when the put ends up in the money with dates when the stock was called away, ie the subsequent short call ends up in the money. These entry and exit dates will define a buywrite strategy that will eventually be combined with the covered combo.

• Paste those dates with the symbol into the Symbol entry part of a Create New backtest.

• Run the buywrite by clicking submit.

• Select the covered combo and the buywrite and the Combine button will appear.

• Set the weights as 1 for each strategy and click ok. You have completed the Covered Combo Wheel.

Here is a recap with pictures and results of an IBM Covered Combo Wheel:

Select Covered Combo in the strategy dropdown menu. You will notice that the Strike Selection is short 30 delta call and short 30 delta put. You can change this if you like. You can even use percentage of the stock price to choose what strikes to trade.

You may also notice that the Stock Position criteria is automatically set to "Overlay". Overlay means that the stock position will be always on, even if there is no options position on at the time.

Run the strategy by clicking Submit.

You will need analyze the trades the covered combo to see when the put finishes in the money. You can see how to download the trades file here: Click on the link of the strategy and hit the button in the top right Download.

When the put finishes in the money: Match up all the dates when the put ends up in the money with dates when the stock was called away, ie the subsequent short call ends up in the money. These entry and exit dates will define a buywrite strategy that will eventually be combined with the covered combo.

For example, above the first short put was called away on 10/19/2007 when the stock finished below the put strike at expiration. Stock was owned at that price and a call was written against the long stock. The short call finished in the money at expiration on 12/21/2007. This is the first trade for the buywrite additional strategy. Here are the rest of the trades. Select and copy and paste into Symbols.

Be sure to select the Stock Position = Married. Married has a stock position only when there is an options position. Overlay or buywrite has a stock position on the entire backtest, from start date to end date.

Why a buywrite? When the put finishes in the money, this Wheel strategy adds the rule that the stock will be kept and an additional short call will be traded against that stock, hence a buywrite equals long stock and short call so this is the strategy that we will track in addition to the covered combo.

Run the buywrite by clicking submit.

Select the covered combo and the buywrite and the Combine button will appear.

Set the weights as 1 for each strategy and click ok. You have completed the Covered Combo Wheel.

Here are the results of the IBM Covered Combo Wheel using the defaults.

Notice that while the annual return is better, the combined Sharpe is not as good as the covered combo itself. Looking at the returns for the combined strategy, especially in 2008, we can see why the Sharpe, which used volatility, is not as good.

Click on the combined strategy to see all the statistics and trades.

Here's how the Overlay stock compares to a Married stock position in the Trades section:

The first row of trades above is the short call in the buywrite with Married stock. Notice how the stock in the second row enters and exits with the short call. The third row is the covered stock portion for the entire backtest that enters the first day of the test, 1/3/07 and exits the last day of the test 5/8/19.

Try it by going to wheel.orats.com

For more videos and instruction go here.