Deep In The Money Bull Put Spreads

Someone compared a Deep ITM Bull Put Spread strategy to a lottery.  Indeed, it is anything but.  Rather, it is a very sound, safe strategy.  Consider that Bull Put Spreads are credit spreads, and the deeper ITM you go, the bigger the credit (i.e., money in your pocket).  Also, the farther out you go in time to expiry, the greater the chance that the stock will make a big move.  For example, let's take AAPL.  At its current market price, $676 or so, a Deep ITM Bull Put Spread might be something like a 2014 expiry 770/780 Bull Put Spread, which will fetch approximately $700 per margin of $1000 per contract ($770-$780=$10 x100 per contract=$1000), or 70% return, with a risk of 30%.  How do I figure the risk?  Simple: You receive $700 credit for each contract, and while the margin requirement is $1000 per contract, the $700 mitigates against that, thus reducing your out of pocket, and putting you at risk for only $300 IF the stock does not make the expected move, and IF you choose to keep it open until expiry.  In this case, you are about $100 ITM (AAPL $676; strike price $780), but your risk is only 30% if AAPL fails to reach $780 by Jan. 2014.  Moreover, you are not obliged to hold on to this spread until expiry.  If AAPL comes out with new products or wins another legal case, or declares a split, or whatever, it could surge, thereby lowering the spread amount, in which case you can buy it back to close.  Even if AAPL does not surge, but simply meanders slowly through the months, at $780, you are assuming a $104 rise in the stock price, which represents a 15.3% rise in 18 months, certainly within the realm of possibility for this stock.  Again, the credit (money in your pocket) is 70% on a risk of 30%.  In my book, that is not a lottery ticket at all, but a very sound strategy.

A Bull Put Spread is a strategy where the underlying stock can stay the same (you profit by the erosion of time), rise (you profit by the decrease in the puts) and even decline a little (by the amount of the credit received).

Is there a risk to this strategy? Yes, and here it is: If AAPL falls precipitously in price, the Bull Put Spread INCREASES in value.  Thus, it may trigger a margin call, unless you are very well funded.  The operative word here is may.  There are many situations where the market takes a tumble, even a severe correction, yet nothing happens to your long-term positions.  On the other hand, you may be called upon to reduce your margin, in which case, you simply buy the spread to close.

Remember: A PUT increases in value as the underlying stock price decreases.  A CALL increases in value as the underlying stock price increasees.