An Easy Euro Trade
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- Published on Monday, 02 July 2012 08:00
- Written by Sara Nunnally, Editor, Inside Investing Daily
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Don't buy the latest bailout rally. Just like all the others... it won't last. Here is how you profit from the fading optimism.
By now, you've heard all kinds of opinions on the Supreme Court's ruling on Obamacare... You probably don't want to hear mine.
But here it is anyway: I don't give a hoot.
It doesn't amount to a hill of beans for what I've been looking at for Macro Trader.
I'd rather talk about why the markets -- including gold and oil -- bounced back so sharply on Friday... because hidden in that good move higher is a potential threat you need to know about.
Friday morning, the markets soared on news that the European Union agreed to another bailout. This time for banks.
From The New York Times:
Working through the night in the face of pressure from the embattled eurozone countries Italy and Spain, European leaders agreed early Friday to use the Continent's bailout funds to recapitalize struggling banks directly, according to the European Council president, Herman Van Rompuy.
Financial markets, which had expected little from the meeting, welcomed the announcement, suggesting it had exceeded expectations -- though analysts cautioned that earlier summit agreements had prompted rallies that proved short-lived.
The Dow jumped 1.6% in the first 10 minutes of trading. Gold climbed 3%, and oil rocketed 5% higher.
All on news that effectively said, "Our banks are in trouble."
This last sentence is what I really want you to remember about the whole situation. Bailouts and stimulus are only Band-Aids. The underlying policy and mismanagement problems will still remain even when the bailout money is gone.
The only good thing about the deal is it is a direct injection to the banks, not a bailout that needs to be funded from sovereign debt.
That means countries like Italy and Spain don't have to add to their debt burden, which they've been struggling to do. Look at these bond rates:
Italy's offering a 5.916% yield on its 10-year bond, and Spain is offering over 7% for its 10-year bond. Both rates are over 25% higher than they were a year ago.
It is a sign that not a lot of folks want to buy these countries' debt.
But here's the kicker...
The funds won't be available until a bank supervising body has been set up. This should happen by the end of the year.
And that's the main reason this bailout rally will be short-lived. If you're buying into it, do so with great caution. Do you really think oil is worth 5% more overnight?
Or the euro is 2% more valuable?
I don't either...
Check this out:
This is the euro versus the dollar after news of the bailouts. That Friday pop is unstable.
"The burden of future risk is being shared more widely, meaning the chances of a eurozone breakup have been lowered for the short term," said Graham Neilson, chief investment strategist at Cairn Capital, in Bloomberg. "But at the same time, the longer-term ante is higher for all involved and the root causes of the structural imbalances remain."
But this pop could be the perfect time to set up a bearish position in the euro.
The CurrencyShares Euro Trust (FXE:NYSE) put options are an easy way to do just that. And look at all this red in the September put options string:
You will get a good deal.
If you're not familiar with options, let me introduce you to Jared A. Levy, editor of Option Strategies Weekly.
He has an options education series that explains the ins and out of trading options.
In a nutshell, put options give you the right to sell a stock or other asset at a specific price. For the FXE, we're predicting a drop in price. Put options climb in value as the FXE share price falls.
If you think the pop in the euro is unsustainable -- as I do -- you might want to pick up some put options and ride the FXE lower.
How much lower?
I think the FXE could trade back down to $123 in very short order. But from there, I'd be taking profits off the table.
That $123 level is its 52-week low. In fact, the FXE hasn't been that low since June 2010. In other words, the FXE could find support at that low level.
It could be a short ride, but a profitable one.
The FXE September put options are more liquid than the August options. You could probably pick up the September 126 puts for under $2.75. A move to $123 would make these options worth $4.30, a nice 56% gain.
Happy Investing,
Sara
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