Stock Market Paddle Strategy
In January 2008, emails began circulating that tried to sell stock-market analysts on how to benefit from a secret strategy, which the marketers referred to as the "paddle strategy." The phrase "paddle strategy" was most likely simply designed to evoke the old saying about being up a creek without one.
Other People Are Reading
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Background
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In October 2007, the Dow Jones peaked at about 14,000 points and headed down, due largely to concerns about the extent of the loss financial institutions would take from subprime mortgages and related derivatives. The following month, an economist with Goldman Sachs estimated that credit losses on then-outstanding losses from subprime mortgages could reach $400 billion. James Barth, in his book "The Rise and Fall of the US Mortgage and Credit Markets," lists this as the first in several efforts to draw up a "damage scorecard."
Example
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Against that backdrop, marketers for a supposedly proprietary way of prospering in bear markets began to use the expression "paddle strategy." For example, Jim Nelson posted a tease on the website Penny Sleuth, asking readers, "What would you say if I told you that there was an insurance policy for small-caps that also lets you double your money as everyone else loses theirs?"
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Analysis
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Nelson posted his tease on Jan. 23, 2008. On Jan. 24, the website Stock Gumshoe ran a skeptical inquiry into and analysis of "paddle strategy" claims. Although the posts and emails propounding such a strategy tend to be cagey (so as to have something untold to sell), they do give enough away so that discerning readers can tell that they are talking about ways to place bets against the market.
Significance
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There are at least three ways to do this, as Stock Gumshoe outlines: Buy put options (buy the right to sell a specific stock at a specific price by a certain date); buy a reverse or inverse Exchange Traded Fund (ETF); or take a short position on specific stocks that you deem will be hurt as the bear market continues.
A reverse ETF is a complicated derivative instrument that is based upon one of the major stock indexes and that is designed precisely to rise as the underlying index falls and vice versa. There are also "ultrashort" ETFs, which move up twice as much as the index moves down, or down twice as much as the index moves up.
Short selling of a specific stock entails borrowing shares of that stock from a broker-dealer and selling them at the market price. If the price goes down, the short selling can buy the stocks at the new lower price and make good on the loan.
Risks
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Obviously each of those hypothetical "paddles" is extremely risky, and should be employed only by a trader who knows those risks and can afford to lose money. After all, the information that leads you to believe that a certain stock will soon fall in value, and that may thus lead you either to short it or to buy a put option, may already be priced into the value of that stock -- some economists believe this a near certainty.
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