It was called the "million-to-one-chance" trade - but when James Chanos bet that the online gambling business was about to implode he hit the jackpot in one of the sweetest deals of the year.

His hedge fund, Kynikos Associates, had put a large slice of its $3bn in assets on a bold punt that shares in the internet gambling sector were about to go into free-fall.

And on October 2, shares in the companies did precisely that as about $5bn was wiped off their value in just a few hours of trading in response to a US Senate decision to introduce tough new laws cracking down on gambling on the web.

It took the industry and the markets, in fact almost everyone except Mr Chanos and his team of traders, by surprise. The consensus view had been that the sector was about to ride higher on a wave of consolidation.

According to Trader Monthly and other informed market sources, Mr Chanos had borrowed large chunks of shares in companies such as Sportingbet and World Gaming and sold them while their prices were relatively high. He then bought them and returned them to the lender when their price fell, pocketing the difference in a technique known as short selling.

Although only used by the most experienced traders, as losses can be huge if the bet goes wrong, the concept of short selling is fairly simple. In essence, the borrower is selling shares they do not own on the understanding they will buy them and return them to the lender at a later date. The profit, should the market fall, or loss, should it rise, is the difference in the price of the shares at the time of selling compared with the price at the time they are returned to the lender.

Shares in Sportingbet and World Gaming plunged dramatically on October 2, by 58 per cent and 76 per cent respectively, providing Mr Chanos with a golden opportunity to close his positions and clean up.

The sophisticated punt was all the more impressive, given the widespread belief that the Senate would not pass the laws.

Other leading hedge funds and senior figures in the industry had been convinced the Senate lacked the will to push them through. In the words of one senior online gambling director, widely reported just before the market turned, the likelihood of the Senate passing such measures was a "million-to-one-chance". Another prime broker said at the time: "All the hedge funds thought these companies would merge - not tank. Nearly everyone was caught out by this."

As a result, many hedge funds and other leading investors were buying into the sector in anticipation of consolidation. Long-only investors with shares in online gambling stocks included some of the top names, such as Fidelity International, Deutsche Asset Management, M&G, Merrill Lynch and New Star.

So why had Mr Chanos taken such a risky, in the eyes of the consensus, but ultimately winning gamble?

Representatives of Mr Chanos did not return requests for comment on the trade, but most analysts think his acute political antenna had come into play. He is widely regarded to be more tuned in to the Washington political scene than most of his peers.

Certainly, anyone reading between the lines could have predicted the new law, which makes it illegal for banks and credit card companies to make payments to online gambling sites, had a chance of making it to the statute book after the lower house in the US, the House of Representatives, had approved the measure in the summer.

In fact, the "ambush" by Bill Frist - the then Senate majority leader who had been instrumental in successfully steering the key clause on credit card processing through the upper house by attaching it to a little known bill on coastguard security - was perhaps not so surprising given his presidential ambitions.

In the view of some Washington analysts, Mr Chanos had foreseen the "ambush" as he had understood Mr Frist's fierce desire to pass the law in his hope of winning favour with the Republican right and President George W. Bush.

Both Mr Frist and Mr Bush believed such action would go down well in the heartlands of Middle America, where some voters consider the so-called vice of gambling as one of the worst forms of debauchery.

It was this vision-thing, as Mr Bush might have put it, that prompted Mr Chanos to take advantage of the blackest day in the short history of the online gambling industry and turn the "million-to-one-chance" trade into one of the "financial killings" of 2006.