DITM bull put spread

Hi, I am a newbie,

I am trying different bull put spreads with the short leg deep in the money

i.e. on 23 jan 2012 CFX was at 32.77$

Short 40 put @ 7.50 Feb
Long 30 put @ 0.65 Feb


Maximum profit is 685$ and maximum risk is 315$

provided that CFX looks very bullish if the stock goes only slightly up or sideways at expiration it should be very profitable if expires not exercised because you keep all the premium?

This looks a better deal than doing a traditional bull put spread with both legs OTM when you need high margin for a small return.

I do not see possible pitfalls or downsides of the strategy that I am adopting except the risk of having an early excercise of the short put if the price falls sharply.
Would the option exercise be likely or it most commonly happens that whoever has bought the DITM put will sell back the option getting the profit?

Since the downside risk is capped i do not see any particular problem with this strategy.

Can you advise please?

When you say "slightly up or sideways" what exactly do you mean? I think you may have it all a little confused. What do you think happens if your options expire with the underlying at exactly the same price as today, i.e. 32.77?

If the price stays the same and the option expires i should keep the entire premium of the spread. Isn't right?

esculapius1975 said:

If the price stays the same and the option expires i should keep the entire premium of the spread. Isn't right?

Click to expand...

Well, yes, that's sorta right, in a very narrow and not very useful way... You keep the premium, but what happens w/your options? Hint: what does it mean that the 40 put that you're short expires ITM?

Martinghoul said:

Well, yes, that's sorta right, in a very narrow and not very useful way... You keep the premium, but what happens w/your options? Hint: what does it mean that the 40 put that you're short expires ITM?

Click to expand...

II suppose that as whatever other ITM put it could be exercised. But the thing that let me doubt about this is that the option was already bought deep in the money so the fact that this is still in the money does not mean that whoever has bought it will make a profit exercising it.
Would you probably reckon that the most likely scenario will be that the buyers of the 40$ put will sell the option before expiration since on DITM there is very little time value attached to loose?

esculapius1975 said:

II suppose that as whatever other ITM put it could be exercised. But the thing that let me doubt about this is that the option was already bought deep in the money so the fact that this is still in the money does not mean that whoever has bought it will make a profit exercising it.
Would you probably reckon that the most likely scenario will be that the buyers of the 40$ put will sell the option before expiration since on DITM there is very little time value attached to loose?

Click to expand...

You're thinking about it all wrong... Forget early exercise, that's really not material. Forget what the option had been bought for, that's also not relevant for expiration.

If your options expire with the underlying at 32.77, you will keep the premium on the put spread you have sold (in a way, you always keep the premium, so it doesn't really tell you much), so you keep 6.85. However, you will be assigned on the 40 puts and your 30 puts will expire worthless, which will cost you 7.23. Net you will lose 0.38.

Do you think that the 40 put will be assigned anyway even if the price is gone up lets immagine to 35 or 38, whatsoever below 40?

esculapius1975 said:

Do you think that the 40 put will be assigned anyway even if the price is gone up lets immagine to 35 or 38, whatsoever below 40?

Click to expand...

Yes, of course... Unless very specific, very rare circumstances (related to cost of carry considerations) are present, you can safely assume that an ITM option will be exercised. That occurs regardless of what premium you received for it. Not exercising an ITM option will be equivalent to, quite literally, donating money to the mkt. So if you're short, you can pretty safely assume you'll be assigned.

I have found the deeper in the money the option is, the greater chance of early exercising. At expiration, all ITM options will be exercised. There is no real way to know if your short option will be exercised early or not