246  •   The Intelligent Option Investor
No. Buy/Sell Instrument
Price of 
Instrument
Effective 
Buy (Sell) 
Price of 
Stock Note
1 Buy Stock $17/share $17/share Original purchase
2 Sell Call option $1/share $16/share Selling a covered call 
to take profits when 
stock reaches $20/
share leaves the 
investor with down-
side exposure and $1 
in premium income.
3 Sell Call option $0.75 ($11.75/
share)
Stock falls to $11, and 
investor sells another 
covered call to 
generate income to 
ameliorate the loss.
In transaction 1, the investor buys the shares for $17. In transaction 2, 
when the stock hits $20 per share, the investor sells a covered call and receives 
$1 in premium. This reduces the effective buy price to $16 per share and 
means that the investor will have to deliver the shares if the stock is trad-
ing at $20 or above at expiration. When the stock instead falls to $11, the 
investor—wanting to cushion the pain of the loss—sells another ATM cov-
ered call for $0.75. This covered call commits the investor to sell the shares 
for $11.75. No matter how you look at it, buying at $16 per share and sell-
ing at $11.75 per share is not a recipe for investing success.
The first step in such a situation as this—when the price of a stock 
on which you have accepted downside exposure falls—is to look back 
to your valuation. If the value of the firm has indeed dropped because 
of some material negative news and the position no longer makes sense 
from an economic perspective, just sell the shares and take the lumps. 
If, however, the stock price has dropped but the valuation still makes 
for a compelling investment, stay in the position; if the investment is