Short sellers get a bad rap. They are often villainized by the media for “ganging up” on troubled companies or even causing market crashes. 

There is little evidence to support the latter, though, and the truth is short sellers are a necessary part of the market. They help provide liquidity and keep overpriced stocks in check. 

#-ad_banner-#I don’t know about you, but I’m not content only making profits on the upside. There is an extraordinary amount of money to be made on the downside, especially in a market like this.

But when you short a stock, you risk an unlimited loss for a limited gain. I’m a probability guy, and I don’t like those odds. 

Plus, there is a strategy for profiting when stocks fall that offers limited risk and substantial (though not quite unlimited) gains. Given that, I’m not sure why anyone would choose to short stocks. 

Now, my strategy involves options, another area of the market that gets a bad rap. But unlike short selling, options — when used properly — can actually help limit your risk. 

Today, I want to cover how to use basic put options to profit as stocks fall. To do so, I’m going to use an actual trade I recommended. 

Last summer, after taking a look at the weak Dow Jones Transportation Average, I warned that one of its components, a U.S. rail company, was set to drop. The stock in question — Kansas City Southern (NYSE: KSU) — was drastically underperforming the broader market and had dragged the entire transports index lower. 

With shares trading at $99.23 at the time, I anticipated an 8% drop to $91. But rather than advising traders to short KSU, I told them to purchase a put option on the stock. 

A put option gives you the right (but not the obligation) to sell the underlying stock at a certain price (the strike price) at a future date (the expiration date). This allows you to enjoy the stock’s downside with less risk than shorting it outright. 

Specifically, I recommended buying the $105 strike puts expiring in December for $10.30 per share. 

Because each option contract controls 100 shares of the underlying security, the trade cost us $1,030. That was still much cheaper than shorting 100 shares of KSU, though, which would have cost at least $4,961 on a 50% margin. 

The absolute most we could lose was the $1,030 cost of the option. Losses for a short seller, on the other hand, were theoretically unlimited because there’s no telling how high a stock can go. But I also advised readers to add more protection by placing a stop-loss at $5 ($500 for the contract), so the most we actually had at risk was $530. 

The goal was for KSU to drop to $91 by expiration in December. At that price, the put option would be worth at least $14 (strike price of $105 – stock price of $91) and deliver a return of 35.9% within four and a half months. 

That was the maximum length the trade would be open, but I anticipated we’d only need until the end of October, after the company reported Q3 earnings. 

Instead, KSU began dropping like a rock immediately after my recommendation, hitting my target in just 17 days. That translates to an annualized return of 771.3%. 

Last week, I recommended another put option on KSU. Despite weak revenues and other mounting bearish factors, shares have staged a miraculous 35% recovery from their January bottom and are once again looking expensive. 

Perhaps this rally was fueled by extreme profit taking from the growing number of short sellers, but whatever the cause, shares are now ripe for a pullback. 

This time we’re risking just $610 and stand to make a 17% gain in 101 days, or 61% annualized. But if it’s anything like the first time, our target will be hit much sooner and our annualized profit will be much larger. 

Since I began my Profit Amplifier service one year ago, the average put option trade has been open for just 26 days and returned an annualized gain of 918.1%. 

If you’ve ever considered using options, my strategy may be of interest to you. I use it to trade both put and call options, allowing me to make money whether stocks go up or down. I actually developed it when I was 16, and by the time I was 18, I was making $600,000 a year with it. 

I’ve honed it over the years and it went on to make me millions. But after a life-altering event, I decided to leave Wall Street and start sharing it with average traders.

If you’re interested in learning how it works or seeing more of my trade recommendations, follow this link.