Profit During Bad Times

By Michael Shulman

When I say that you don't want to buy a company's shares, you can translate that into the fact that it's OK to look into shorting their shares.

If you're adventurous (or perhaps even a little crazy), you can short stocks directly by selling them outright.

Or you can do it the safer way -- OK, since it's my way, I can call it the "right" way -- and buy put options. That's why I call it the "short side" -- you're buying puts as a way of shorting a stock, and your risk is limited to what you spend to buy the puts. Better yet, your upside potential can be unlimited!

Finding the Best Companies to Short

My tried-and-true method of finding stocks to short, via buying put options, has been to exhaustively research a company's "fundamentals." It's exactly what it sounds like -- looking at a company's foundation, from its leadership to its core products and everything in between -- and seeing how many cracks there are and evaluating how possible it is to fix them in a reasonable amount of time.

If you don't have a specific company in mind, think about the various sectors out there. You can narrow those down to find the well-run companies that keep increasing their sales and coming out with more innovative products every year. (You have my blessing to think about buying their stocks!)

Then you separate the stars from the slugs. Do you see a company or two that couldn't make a good decision or manufacture a successful product to save its life? Do you hear about executives dropping off like flies and see its competitors absolutely crushing it in the marketplace? That might be a great place to start your short-side journey.

Opportunities Everywhere

Going back to our consumer spending example, people start cooking at home more when money is tight. So, you might examine restaurants and department stores as natural avenues for short-side profits.

Personally, I've noticed that it takes half as much time to get a pair of pants hemmed at my favorite clothing store because their seamstress isn't deluged with alterations requests. I've also started getting seated immediately at restaurants where you had to leave your name at the hostess station two hours before you think you would be feeling hungry.

Take a look to see if the stores, restaurants, manufacturers and other names you come up with in your research (or simply your everyday experiences) are publicly traded, and make sure they have an options chain available.

Also check out things like short interest, which can let you know how many traders have shorted the stock the traditional way. If the number is high, chances are that put premiums might be expensive, too, as other people have gotten the hint that poor sales this quarter are going to translate into less-than-stellar earnings next quarter.

Which Put Positions Should You Pick?

Then take a look at the at-the-money or slightly out-of-the-money puts in the option chain. If XYZ Company is trading for $35 a share, but you can hear crickets when you walk into their establishment, you could check out the at-the-money puts at the $35 strike or even opt for the out-of-the-money puts at $32.50 or even $30.

Just be sure to buy yourself enough time for the trade to work in your favor -- while longer-dated options (also called LEAPS) can let you buy up to two years of time, those tend to be more expensive. If you're looking to be in a trade until its next quarterly earnings announcement, though, you may want to buy options that expire in four to six months so that you can benefit from any bad news that may come out three months from now.

Playing the short side with puts is an exciting adventure that is actually independent of how the market performs, as we've made short-side profits on days that the Dow (DJI) jumped 200 points. But when the market's stuck in neutral or reverse, the negative sentiment tends to drive up put premiums -- good news for us when we're betting on a stock or sector going down anyway.

A bad day in the markets can accelerate your returns on a good short-side trade. And I've never been one to get mad at making profits faster than I planned! I hope you'll check out my ChangeWave Shorts service and get in on all the latest trades -- I'm finding new companies each day with worse fundamentals than the last, and I'd love to have you on board for the next round of happy returns. Try it out -- risk-free for 90 days!

Michael Shulman is the Editor of ChangeWave Shorts.