Wheeling those high-premium stocks without the risk

I had an interesting conversation with a Lancer named Alex on my way into work. He wanted to wheel Novavax (NVAX), which is another one of those junior varsity pharmaceutical companies competing with the big boys to be the first to complete a COVID-19 vaccine.

The appeal of NVAX is real when it comes to yield. The stock trades for about $140, so a trader with $14,000 in capital can sell ATM cash-secured puts (csp) for a weekly premium. And given the hype around the race for a COVID-19 vaccine, premiums on NVAX options are sky high. A $140csp expiring a week out is selling for a good $1,600 in premium.

Earnings season is boosting that premium a bit. But as Alex and I agreed, the appeal of NVAX isn’t its earnings. As a pharmaceutical company with no drugs on the market, the appeal is the prospect of discovering the COVID-19 vaccine. As long as no one cancels Coronavirus, NVAX will retain its appeal. Even if that were to happen, NVAX does have some other vaccines in its pipeline that make it a viable company.

Alex wanted to wheel NVAX to grab that heavy premium. He was prepared to put up $14,000 in collateral to sell cash-secured puts in exchange for that ridiculous weekly premium. But the risk of selling cash-secured puts is that the stock may tank and cost him an arm and a leg. Can we devise a plan in which Alex can still wheel NVAX while protecting him in case the stock burns down? YES. We will get there.

tl;dr Hedge your wheel with a put LEAPS. This will create a put calendar spread. If assigned, hold your put LEAPS and sell covered calls. This will create a collar spread. Continue flipping between put calendar spreads and collars while you spin the wheel to collect premium and you’ll more than cover the cost of the put and be entirely protected from loss.

The Risk

Alex had serious concerns about wheeling NVAX because of the risk that the stock could get hammered, forcing him to buy shares for $140/ea when the stock is trading much lower. Here are some risks we discussed that could wreck the stock:

1) NVAX coronavirus vaccine studies could fail a clinical trial, which would set the company back months and take them out of the race for a vaccine;

2) Another company could produce a vaccine first, rendering moot any other efforts to create a vaccine;

3) America could get its shit together and stop spreading the virus, reducing the excitement about a vaccine;

4) NVAX could go bankrupt before discovering a vaccine;

5) Investors could start favoring another company as the front-runner and moving their money into that stock instead.

With all those risks in mind, Alex needs to protect himself from a stock drop. Here’s what we came up with.

Step 1 of the Solution: Buy Put LEAPS as a Hedge

Alex needed to protect his investment from a heavy drop, so the solution is to utilize a long-dated put.

As he is wheeling, the put will protect him from a dramatic drop in stock price. He will continue to collect premium from the wheel, and if the stock drops, he will be able to execute the put to ditch the shares, or just sell the put itself for a profit.

But there is an obvious problem here: you have to spend money to buy the put. Entering a position like this will come as a debit.

Let’s look at Alex’s trade:

Wheel: Sell to open 1x NVAX $140 cash-secured put expiration 7 Aug for $1,600
Hedge: Buy to open 1x NVAX $140 put expiration 21 Jan 2022 for $6,800

Total cost and max loss: $5,200

Indeed, Alex can enter the wheel on NVAX with a max loss of $5,200 if NVAX goes to $0 next week.

For those in the know, this is effectively a really long-dated put calendar spread.

Step 2 of the Solution: Play the Put Calendar Spread with Wheel

Alex is now $5,200 into the game. When August 7 rolls around, 1 of 2 things will happen:

1) Alex gets assigned. He will buy 100 shares for $140/ea;

2) The cash-secured put expires worthless and Alex realizes the premium.

If Alex does not get assigned, he simply come back and sell another cash-secured put the following week and collect more premium. His put LEAPS will have gone down slightly from theta decay and potentially from delta if NVAX went way up, but this loss should be minimal since there is so much time until expiration.

Step 3 of the Solution: Get Assigned and Play the Collar

If Alex gets assigned, he will buy shares at $140/ea. He will then switch to selling covered calls to collect more premium. 

Also, if he is assigned, that will imply that the stock dropped below $140, so his put LEAPS will have grown in value as well.

Alex’s position will consist of holding 100 shares, selling a covered call, and holding a put as a hedge. This is now a collar spread with a calendar aspect.

The Goal: Get to $0 Risk

By the end of week 1, Alex will have a basis in his position of $5,200. Whether assigned or not, he will still be holding a put that doesn’t expire until 2022. 

If he goes unassigned, he will sell another cash-secured put for, let’s say conservatively, $900 expiring a week later. This will bring his total investment into the position down to $4,200.

If assigned, he will switch to selling covered calls and pull approximately the same premium. The total cost of the position is now still $4,200. 

And by the way, unless the stock has risen quite a bit, your put LEAPS is probably already worth more than that. You have not reduced your position for $0 cost, but you are already profitable.

Let’s carry this out a few more weeks:

- Week 3: Sell covered call for $800; cost basis now $3,400; assigned

- Week 4: Sell cash-secured put for $600; cost basis now $2,800; not assigned

- Week 5: Sell cash-secured put for $600; cost basis now $2,200; assigned

- Week 6: Sell covered call for $1,000; cost basis now $1,200; not assigned

- Week 7: Sell covered call for $500; cost basis now $700; assigned

- Week 8: Sell cash-covered put for $700; costs basis now $0; assigned

Within 2 months, Alex brought his cost basis down to $0, and he is still holding a $140 put expiring in 14 months. He can continue his wheel without risk, or if he’s done, sell the put. The value of that put is his profit.

This might be an optimistic view. But even if it were to take twice that long to reach $0 basis, that still leaves an entire year in which to continue the wheel without risk.

Final Thoughts

The above is a rosy picture of how this trade could play out. Keep in mind that if NVAX were to rocket to $300 on their vaccine going public, the put’s value will get a 70% haircut and you’ll get priced-out of wheeling at $140. You’ll experience some level of loss depending on how many successful wheels you ran before NVAX ran away.

This strategy can also be effective without such a significant binary event as creating/not creating a vaccine. Those circumstances would lead to more stability in the stock, but they would also pay fewer premiums as a result.

Ensure you are not entering a wheel just for the yield. This strategy requires patience, so do not succumb to FOMO or fear when using this approach. Continue your wheels, hold your put LEAPS, and make bread with consistency.