Ep89 - Using Skew to Make Better Wheel Trades

In this episode, Dan explains how volatility skew can help traders make more informed decisions when selecting strikes for covered calls and cash-secured puts. He starts with the volatility risk premium behind option selling, then breaks down how implied volatility can vary across different strikes on the same stock. That difference, known as vertical skew, can reveal where option buyers and sellers are creating unusual pricing opportunities.

Dan explains the typical volatility pattern, why lower-strike options often carry higher implied volatility and what it means when that relationship changes. Using a real-world example, he shows how strong demand for calls can create an upward-sloping call skew, giving Wheel traders richer premiums at higher strikes but also signaling greater upside risk. He then shows how the same analysis can improve cash-secured put selection and even help evaluate covered strangles.

Key Topics

• Why the volatility risk premium matters to Wheel traders

• What volatility skew is and why it develops

• The difference between horizontal and vertical volatility skew

• Why lower-strike puts typically have higher implied volatility

• How covered call selling can influence volatility at higher strikes

• What an upward-sloping call skew can reveal about market demand

• Using Newmont Mining as an example of abnormal call skew

• Balancing richer covered call premiums against greater upside risk

• How skew can improve cash-secured put and covered strangle decisions

• Using implied volatility across strikes to improve Wheel strike selection

Key Takeaways

• Skew shows that implied volatility isn't the same at every strike. Options on the same underlying can trade at different implied volatilities depending on their strike price, creating a slope across the option chain.

• Normal skew is largely driven by supply and demand. Investors frequently buy lower-strike puts for protection, which can increase their prices and implied volatility. At the same time, covered call sellers create natural supply in higher-strike calls.

• Some stocks develop an unusual call skew. When traders aggressively buy calls in fast-moving, popular or momentum-driven stocks, successively higher call strikes can actually carry higher implied volatility instead of lower volatility.

• Higher implied volatility can mean richer premium, but it isn't automatically an edge. The reason calls are expensive may be that the market sees legitimate potential for a large upside move. Traders need to evaluate why the skew exists before assuming the additional premium is attractive.

• Newmont Mining provides an example of upward-sloping call skew. Dan shows how implied volatility increased as the call strikes moved higher, reflecting a stock that had demonstrated the ability to make substantial upside moves.

• A richer covered call comes with a trade-off. Selling a higher-strike call at elevated implied volatility can produce more premium, but the stock may also be more likely to make the kind of move that forces an adjustment or causes the trader to give up upside.

• Tracking aggregate premium helps put adjustments in context. Dan explains that knowing how much option premium you've collected over the life of a Wheel position can help determine whether accepting the possibility of a negative scalp or adjustment makes sense.

• There is no universal rule for unusual skew. An upward-sloping call skew doesn't mean traders should always sell covered calls or always avoid them. The decision depends on the stock, the potential upside move, adjustment possibilities and the additional premium available.

• Skew can also benefit cash-secured puts. When lower put strikes carry increasingly higher implied volatility, traders may be able to sell out-of-the-money puts at richer volatility levels. In some cases, both sides of the skew can also make a covered strangle worth evaluating.

• Make skew part of your normal option-chain analysis. When evaluating a Wheel trade, don't look only at the implied volatility of the strike you're considering. Scan the strikes above and below it to see whether another strike offers a better combination of premium, room for the stock to move and annualized return.

Connect
Try the Wealth Builder trading platform, designed specifically for Wheel traders. It tracks aggregate premium over time and provides tools to help evaluate underlying stocks and optimize potential Wheel candidates.

Users who upgrade to Wealth Builder Pro also get access to a professional-level discounted cash flow model for valuing stocks.

Visit MarketTaker.com/WB (markettaker.com/WB) to start a free 7-day trial of the Wealth Builder platform.

Subscribe to Wealth Building With Options in your favorite podcast app and leave a comment to let Dan know what you'd like to hear covered in future episodes.

To learn more about Dan Passarelli and Market Taker Mentoring, visit MarketTaker.com (markettaker.com).

Disclosure:

Options involve risk and are not suitable for all investors. Prior to buying or selling an option, investors must read Characteristics and Risks of Standardized Options (ODD), which can be found at theocc.com/company-information/documents-and-a…

Don’t trade with money you are not prepared to lose. Anything discussed on this show is intended to be generalized information and not intended to be a recommendation to buy or sell any security. The host and guests are not familiar with listeners’ specific situations. For trading information relevant to your specific needs, speak with a licensed broker or advisor.

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