Michael Shulman

5 Short-Side Investment Rules

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I have avoided some short-side positions because the premiums on the puts were simply too expensive --and therefore the risk/reward ratio was unfavorable. The lower the put entry price, the more money you can make when it turns in your favor. Accordingly, if things don't go our way, then that's less money we put at risk.

If a $4 put only goes to $5, it's a gain, of course. But if you're only in the market for 25% gains, you may be better off sticking with stocks.

Fourth rule -- Look for a perfect storm

There are many reasons to short a stock. If you wouldn't be caught dead owning the shares, that's a pretty good indicator that it belongs in your short-side portfolio. But how do you go about picking the biggest losers?

Like the saying goes, "It's what's inside that counts." And if a company, stock or sector is ugly on the inside, it's only a matter of time before the ugliness -- in the form of broken business models, less-than-spectacular corporate leadership, companies that are no longer true competitors in their fields, and other conditions that signal their crumbling fundamentals -- shows on the outside. And then the stock goes down.

Martha Stewart Omnimedia (MSO) is a great example of a two-pronged recession play -- as it has been impacted by both the housing depression and the pullback in consumer spending.

Given that the consumer drives up to 70% of the economy, and also given that our Alliance data told us that consumers across various income brackets were going to be toning down their spending going into 2008, we saw Omnimedia as a perfect target, as it was barely profitable when consumer spending was on track.

Even better for us, it is also a poorly managed company, which meant that even if the company recognized its flaws, it couldn't execute a turnaround in its business model within a reasonable time frame -- if at all.

Throw in some lackluster holiday sales and a bleak outlook (because, if it doesn't make its money around the holidays, then when will it?), and your feeling of pity for this company is the only thing that will keep you from enjoying outsized profits!