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As with the bourses of other eurozone members, the Spanish markets continue their exuberance. The Ibex 35 is at levels not seen since March, up over 38 percent since its July lows. Government bond yields have continued to fall since July and are approaching their lows of the year. This is despite the facts that its financial system is insolvent, its housing market is in shambles and social upheaval is the new normal. Trash collection is sporadic in some regions, government salaries to workers like bus drivers and health-care attendants are not always paid, and, with youth unemployment over 50 percent, riots might become a permanent urban fixture. The comedy that is Spain might be funny if it wasn't all too real.

Recent data suggest that fallout from the housing bubble is still accumulating. The Spanish National Statistics Institute (INE) reported that house prices fell by an average of 15.2 percent in Q3, the biggest quarterly drop since the crisis began in 2008. The government is even considering gimmicks like offering residency permits to foreigners who purchase properties for greater than 160,000 euros. Gayle Allard, of the IE Business School in Madrid, noted: "If they're going to show the same kind of behavior that U.S. and U.K. house prices did, they'd have to fall another 20 or 25 percent. But it looks like Spain's bubble was bigger, so prices would have to fall even further than that."

The housing capitulation has forced Spanish banks to cut costs in efforts to rid their books of toxic assets. Banco Santander (NYSE:SAN) announced that it will absorb and close 700 of its subsidiary Banesto and Banif branches. Bad mortgages contracted by Spanish banks have surged to a record $250 billion, as signatories "walk away". Considering that the market capitalization of Spain's banks is only about $150 billion, this figure is disturbing. The Bank of Spain recently revealed that 11.2 percent of loans were in default by the end of October, a 4.1 percent rise representing about $10 billion. The commercial default rate jumped to 16.56 percent, while on real estate the figure climbed to an astounding 30.33 percent from 27.39 percent. Spanish banks remain afloat only on account of the more than 365 billion Euros injected by the ECB, but this can't continue indefinitely. There will be a limit to the ECB's line of credit.

With no fundamental shifts in Spain's economy and finances, there is little to suggest that market exuberance will continue. To take advantage of what appears to be an over-bought market, there is iShares MSCI Spain Index (NYSEARCA:EWP). This ETF comprised of Spanish equities is heavily weighted toward financials, about 42 percent, with Banco Santander the largest individual holding. EWP trends the IBEX 35 and is optionable. Although spreads are rather wide, a patient trader can acquire a good-value option with a limit order. On the call side, January and April 30 calls have most open interest for their months. On the put side, January and April 25 puts and July 27 puts have most open interest for their months. It is interesting to note that July puts outweigh calls by a great margin.

The divergence between Spain's markets and its fundamental outlook has increased for five months. Spanish bond yields and equity prices will ultimately fall in line with reality, and that reality is not so attractive.

Source: Spain's Pain Not Reflected In Markets