Profiting From A Dire Situation: Short The Euro

Jan.16.12 | About: ProShares UltraShort (EUO)

By this time it is quite clear to almost everyone that the European markets and the European economy in general are in a world of hurt. Several countries within the European Union are laden with debt, and just this past Friday S&P downgraded the credit ratings of nine European countries. The news rocked the markets but should not be a huge surprise to anyone. The EU has been struggling to deal with its financial crisis for years now.

In comments by S&P related to the downgrade, they gave examples of concerns that they have, not the least of which was a failure of Greece to come to terms with its private creditors. In an increasingly dire situation it has become clear that there is a risk of a very messy default. The S&P was also very critical of the steps taken so far by the EU to deal with the crisis.

So how do investors profit from an otherwise dire situation? A good way to do this is to short the Euro. Proshares Ultra Short Euro (NYSEARCA:EUO) gives a 2X inverse of the USD price of the Euro. As the Euro goes down in value versus the US dollar, the fund's stock price goes up.

Let's take a look at the 3 month chart from Yahoo Finance (click to enlarge):

(c) Yahoo 3 month stock price of EUOClick to enlarge

The ETF has obviously done quite well during this latest period of trouble in the EU. The question investors have to ask themselves is whether or not they think this trend will continue. To that I would say let recent history be the judge. Each time a new plan is rolled out, the markets rejoice, only to realize later that the solution might not work or other unforeseen problems, such as the breakdown in talks between Greece and their creditors, or the reaction of the public in these countries, hinder the progress toward a solution.

My guess is that we are several months, if not years, away from sorting out the whole EU financial situation. Until that time, putting some money on Euro shorts is a smart investment and a hedge against the markets receding during periods of financial chaos and uncertainty. Be aware though, it may take a strong stomach, as solutions are rolled out and praised, only to be discredited later as the reality of the depth of the problem sinks in.

Disclosure: I am long EUO.