The European sovereign debt crisis has proven worse than many initially expected. Despite several bailouts and increasingly long-term liquidity programs, S&P believes there's a one-in-three chance the Greece leaves the eurozone and Spanish yields are above the 6% mark. So, where does that leave investors?
Betting on a Euro Decline
The euro has fallen substantially over the past two years, but it hasn't quite hit its lows in late 2010 when the crisis began. After breaking through a key support level at 1.25 against the U.S. dollar, many traders see a slight recovery followed by renewed declines. And these declines could pickup if Greece exits the eurozone or the situation worsens.
Investors looking to bet against the euro have several options beyond simply going long or short the ProShares UltaShort Euro ETF (EUO) or the ProShares Ultra Euro ETF (ULE). In particular, the options on these ETFs could provide a much better way to bet on the currency with a hedge. Here are some options strategies to consider:
- Covered Calls - Investors betting on the euro's decline may want to consider purchasing the EUO and writing out-of-the-money call options against the position on a regular basis. The income from these options can help offset the cost and lower the breakeven point over time, resulting in less risk for the investor.
- Diagonal Spreads - A lower cost option position for investors is a diagonal spread, which involves purchasing in-the-money EUO call options and writing out-of-the-money calls against the position. The total risk of the position is therefore simply the cost of the original EUO calls that can also be reduced over time.
Investing in a Turnaround
Investors willing to take on a lot of risk for a lot of potential reward may want to consider investing in a potential European turnaround. European banks may be a great way to do this given that many are trading below their tangible book values and near their crisis lows. But given the risk, investors are best off purchasing ETFs versus individual stocks.
The iShares MSCI Europe Financial Sector (EUFN) and the Vanguard Europe Pacific ETF (VEA) are two European financial ETFs worth considering. Alternatively, investing in hard-hit U.S. banks with exposure to Europe is another option worth considering that entails less risk. However, the sector as a whole may benefit significantly from any signs of Eurobonds or other possibilities.
Here are some ways to invest in these ideas:
- Euro Hedge - Investors looking to bet on banks undervaluation, while factoring out some eurozone risk, may want to consider shorting the euro and going long European banks. The result is a pairs trade that may partially isolate this opportunity, but there's always a risk that loans could be allowed to default, and the euro would eventually benefit, leaving the investor in a lose-lose position.
- Protective Puts - Investors looking to hedge against a catastrophic decline may want to consider purchasing these ETFs with some protective puts to limit downside. Purchasing put options in the same amount as the ETFs offers a set selling price. Alternatively, purchasing just call options could limit downside to the price of those call options, too.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.