The Mindworm

According to one of my writing instructors, there was a concept in Mideval fiction called the "Mindworm."  According to this theory, a story should be like an earwig, a little insect that crawls in one of your character's ears.  By the time it crawls out the other side, it should have eaten your character's mind.  It should, to put it another way, reveal everything important that there is to know about the character.  This means that there has to be a match between the character and the situation.  In fact, viewed this way, a plot is nothing other than what a character does in a given situation.  If the situation is too large or too small for the character, it is a mismatch.  this implies a level of balance between the inner and outer life that a writer must learn to understand or intuit.  You wouldn't want to watch James Bond deal with a 7-11 holdup, would you?  Entirely too small to expose his true nature.  Would you want to watch Spongebob Squarepants deal with a serious family crisis?  How about Woody Allen as a lawyer representing Micheal Jackson (no, wait...that might be hysterical.  Let me call my agent...)
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The inner and outer worlds must match.  We are what we do.  We manifest our true natures in the world.  This is another crucial aspect of this writing system, a system designed not just to make you a better writer, but a better, healthier, more balanced human being. 

Assignment:  Start with a character.  What situation would be his or her worst nightmare?  And how could it turn into the best thing that ever happened to him?  Or conversely, what would be his fondest dream, and how could it turn into his worst nightmare?