Chapter 2: Covered Call Writing 71 
1. protective action to take if the stock drops, 
2. aggressive action to take when the stock rises, or 
3. action to avoid assignment if the time premium disappears from an in-the-money 
call. 
There may be times when one decides to close the entire position before expiration 
or to let the stock be called away. These cases are discussed as well. 
PROTECTIVE ACTION IF THE UNDERLYING STOCK DECLINES IN PRICE 
The covered writer who does not take protective action in the face of a relatively sub­
stantial drop in price by the underlying stock may be risking the possibility of large 
losses. Since covered writing is a strategy with limited profit potential, one should 
also take care to limit losses. Otherwise, one losing position can negate several win­
ning positions. The simplest form of follow-up action in a decline is to merely close 
out the position. This might be done if the stock declines by a certain percentage, or 
if the stock falls below a technical support level. Unfortunately, this method of defen­
sive action may prove to be an inferior one. The investor will often do better to con­
tinue to sell more time value in the form of additional option premiums. 
Follow-up action is generally taken by buying back the call that was originally 
written and then writing another call, with a different striking price and/or expiration 
date, in its place. Any adjustment of this sort is referred to as a rolling action. When 
the underlying stock drops in price, one generally buys back the original call - pre­
sumably at a profit since the underlying stock has declined - and then sells a call with 
a lower striking price. This is known as rolling down, since the new option has a lower 
striking price. 
Example: The covered writing position described as "buy XYZ at 51, sell the XYZ 
January 50 call at 6" would have a maximum profit potential at expiration of 5 points. 
Downside protection is 6 points down to a stock price of 45 at expiration. These fig­
ures do not include commissions, but for the purposes of an elementary example, the 
commissions will be ignored. 
If the stock begins to decline in price, taking perhaps two months to fall to 45, 
the following option prices might exist: 
XYZ common, 45; 
XYZ January 50 call, l; and 
XYZ January 45 call, 4.