276 Part Ill: Put Option Strategies 
The purchase of an out-of the-money put option can eliminate the risk of large 
potential losses for the covered write, although the money spent for the put purchase 
will reduce the overall return from the covered write. One must therefore include 
the put cost in his initial calculations to determine if it is worthwhile to buy the put. 
Example: X'YZ is at 39 and there is an XYZ October 40 call selling for 3 points and an 
XYZ October 35 put selling for ½ point. A covered write could be established by buy­
ing the common at 39 and selling the October 40 call for 3. This covered write would 
have a maximum profit potential of 4 points if XYZ were anywhere above 40 at expi­
ration. The write would lose money if XYZ were anywhere below 36, the break-even 
point, at October expiration. By also purchasing the October 35 put at the time the 
covered write is initiated, the covered writer will limit his profit potential slightly, but 
will also greatly reduce his risk potential. If the put purchase is added to the covered 
write, the maximum profit potential is reduced to 3½ points at October expiration. The 
break-even point moves up to 36½, and the writer will experience some loss if XYZ is 
below 36½ at expiration. However, the most that the writer could lose would be 1 ¼ 
points if XYZ were below 35 at expiration. The purchase of the put option produces 
this loss-limiting effect. Table 17-2 and Figure 17-2 depict the profitability of both the 
regular covered write and the covered write that is protected by the put purchase. 
Commissions should be carefully included in the covered writer's return calcula­
tions, as well as the cost of the put. It was demonstrated in Chapter 2 that the covered 
writer must include all commissions and margin interest expenses as well as all divi­
dends received in order to produce an accurate "total return" picture of the covered 
write. Figure 17-2 shows that the break-even point is raised slightly and the overall prof­
it potential is reduced by the purchase of the put. However, the maximum risk is quite 
small and the writer need never be forced to roll down in a disadvantageous situation. 
Recall that the covered writer who does not have the protective put in place is 
forced to roll down in order to gain increased downside protection. Rolling down 
merely means that he buys back the call that is currently written and writes another 
call, with a lower striking price, in its place. This rolling-down action can be helpful 
if the stock stabilizes after falling; but if the stock reverses and climbs upward in price 
again, the covered writer who rolled down would have limited his gains. In fact, he 
may even have "locked in" a loss. The writer who has the protective put need not be 
bothered with such things. He never has to roll down, for he has a limited maximum 
loss. Therefore, he should never get into a "locked-in" loss situation. This can be a 
great advantage, especially from an emotional viewpoint, because the writer is never 
forced to make a decision as to the future price of the stock in the middle of the 
stock's decline. With the put in place, he can feel free to take no action at all, since 
his overall loss is limited. If the stock should rally upward later, he will still be in a 
position to make his maximum profit.