I understand how a short squeeze or earnings surprise could devastate a short/long put position in the span of a few weeks, but on a year's timeframe it's hard to see how Sears would surprise to the upside. They're closing several stores a day, they're increasingly unable to procure inventory, unable to borrow at rates lower than their (negative) ROA, and they probably don't have the cash for effective initiatives to change anything at this point. This strategy of shrinking only reduces cash flow / debt coverage. January would be a great time to file for bankruptcy.
Also, bankruptcy may be baked into the stock price, but I don't think it's baked into the options prices. That would be a deviation from options pricing models used by market makers, which are based more on volatility than business prospects. Looking at their operations makes me surprised that anyone (ETF investors like myself, perhaps?) is paying $4/share or buying their debt at even 25% promised returns. Circuit City had better turnaround opportunities weeks before their closure.
Yet, I hear ya on the risks of short/synthetic shorts. No "infinite loss potential" positions for me, thanks.
The rationale is that the market is offering a double-or-nothing opportunity and it's up to us to decide if SHLD's odds of a price collapse in the next 13 month are greater than 50%.