If the article is correct, and Paulson was actually short on ABX and mortgage-backed securities, the downside of his strategy was unlimited. Taleb's strategy (option trading) had a bounded loss.
It's unclear how balanced Paulson's fund was/is, but the article makes it sounds like he was playing with fire.
Yeah that was half his scheme, which is unbounded as you say.
The other half of the strategy, which the quote was about, was related to purchasing credit-default swaps, which are derivatives like options. The losses on CDS contracts are bounded.
But you're right... without knowing the balance between CDS contracts and short selling, it's hard to gauge how exposed he was.
He was talking about the downside loss strategically - not in the pedantic sense you are using.
Re:Trader Made Billions on Subprime
by kingkongrevenge on Tuesday January 15, 2008 @10:52PM
(#99060)
> he was playing with fire.
You only make $15 billion with a shit-ton of leverage.
However in principle, this is exactly how Nassim Taleb (the Black Swan author) made his money during the 1987 wall street crash (iirc). At the time, people were selling options that hedged against large falls in price very cheaply. Taleb bought loads of them and profited hugely as a result of the crash.
Paulson's scheme was a little more complicated, but the formula was essentially the same - underpriced hedging instruments + crash = massive profit.
This quote from the article sums it up perfectly: Mr. Paulson became convinced investors were far underestimating the risk in the mortgage market. In betting on it to crumble, "I've never been involved in a trade that had such unlimited upside with a very limited downside," he says.