How a 10% Drop for the Euro Made You 100%
by Karim Rahemtulla, Advisory Panelist
Tuesday, May 25, 2010: Issue #1267
On February 9, the CurrencyShares Euro Trust ETF (NYSE: FXE), which tracks the performance of the euro, closed at $137.52.
Today, it trades for about $122.50.
Had you shorted the ETF, you’d currently be sitting on a 10% gain.
Not bad. But you could have done 10 times better…
On that day, I wrote an Investment U column, detailing how you could have kicked the trade up a few notches. Specifically, that meant not taking on the unlimited risk of selling the shares short, but by buying two-year LEAP put options on FXE instead.
To refresh your memory, LEAPS give you the right (but not the obligation) to control the underlying shares. One options contract is equal to 100 shares. And the benefit of buying LEAPS is that it costs you less money upfront, thus significantly reducing your risk. Plus, you get more time for the trade to play out in your favor and can supercharge your returns.
As I noted back in February, “If the FXE moves lower, sooner rather than later, the LEAPS will rocket higher.” And that’s exactly how it played out…
A 100% Gain Versus 10%: Three Reasons Why LEAPS Make Sense
With that 10% decline for FXE, the return on that hypothetical two-year LEAP put trade would be more than 100% today. And that was for an out-of-the-money option, too.
So that’s a 10% gain on a risky short-sale trade, or 100% on a much safer, more flexible LEAPS trade. Hmm…
There are three things to take away from this trade:
- Small Move = Big Gain: With LEAPS options, you don’t need a huge move in the underlying security in order to bag a huge return. It just has to move in your direction early in the trade.
- Low Risk: When you buy LEAP puts, your risk is limited to the amount you invested. End of story.
- Invest Less: With LEAPS, your dollars at risk is a fraction of what you’d pay for an outright stock-based trade.
Want to Double Your Money? Be Careful…
On the subject of the euro’s freefall, a couple of readers have written to me, asking about the ProShares UltraShort Euro ETF (NYSE: EUO). This ETF offers twice the return of the euro’s daily moves against the U.S. dollar. For example, if the euro drops by 5%, it would result in a 10% gain for EUO.
Great, right? Be careful…
If you’d shorted EUO instead of FXE, yes, you could have seen gains between 20% and 35%, depending on when you got in and out.
However, these inverse ETFs reset daily and your gains are limited to that day. If you hold for longer, they do not compound. So those numbers are quite optimistic and would have required deft trading skills.
In addition, if the trade turns against you (i.e. the euro rises), you’ll lose twice as much as the move.
And the trigger for the euro’s mess? Look no further than Greece. And you’re not going to believe this story…
Want to Know Why Greece Collapsed? Listen to This…
A few weeks ago, I mentioned that I hosted a dinner with several economics professors. One of them was a very well-known Professor of Economics – a Greek fellow who was also my undergraduate teacher in college.
The other night, we were having drinks and the conversation naturally turned to the problems in his native Greece. He still visits the country frequently and told me an astonishing story about when he recently went back to assist his mother with a real estate transaction.
She sold a home for 350,000 euros ($440,000). Upon the sale, she had to calculate her taxes – and on a house at that price, you’d think the taxes would be quite high. Think again…
Turns out she only had to pay tax on the first $180,000 of “income” and nothing on any amount over that.
My old professor was dumbfounded. He wasn’t the only one! I asked him if he was pulling my leg, but he was serious. In Greece, income over and above that $180,000 level apparently just “vanishes.” It’s not even declared, since there is no tax paid on it.
I am still researching this, but if it’s true and widespread across the country (and I have no reason to doubt what my friend is saying), then you can see why Greece cannot balance its books.
You can also see how much of an uphill battle countries like Greece face when they’re unable to maintain fiscal responsibility.
So what can you take away from this?
If the Euro Rallies to $1.30, Make This Trade…
In short, I think Greece will ultimately default on its sovereign debt.
It just doesn’t have the means to pay it off and the recent European Union/International Monetary Fund bailout merely delays the inevitable. And of course, the worst part is that it comes at the expense of European citizens.
The Eurozone is a mess and this is just the beginning of the pain for the PIIGS (Portugal, Italy, Ireland, Greece, Spain), not the end. That means the crisis for the euro is also far from over and the fallout will continue to dog the European, American and global markets for the foreseeable future.
What should you do: Simply put, the market isn’t signaling good things to come. In fact, it’s signaling the opposite. So look for rallies in the euro as an opportunity to go short on the single currency once again, especially if it rallies back up to the $1.30 level.
Karim Rahemtulla
Related Investment U Articles:
- LEAP Option Investing: Know These Five Factors Before Using This Strategy
- These “PIIGS” Aren’t Flying… But Here’s An Investment That Will
- LEAP Option Spreads: Tame the Market With This Risk-Blasting Strategy
- Ultra ETFs: Whether You’re Ultra-Long, Or Ultra-Short… Be Ultra-Careful
- LEAP Bear Spreads: If You Want to “Go Short,” This is the Way to Do It
6 Responses to “How a 10% Drop for the Euro Made You 100%”
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Dubbed a "market maven" by CNBC, Karim Rahemtulla is one of the country's foremost specialists in options trading. As founder and editor of The Smart Cap Alert, he focuses his efforts on all aspects of options trading – LEAPS, put selling/covered calls and spreads. 
Greeting from Greece,
I always read your comments and i congratulate you and the website for all the valuable info you are giving us. However i have to set the record straight as i am Greek Equities & Derivatives Broker and i know a few things about real estate transactions.
Maybe your friend didn’t speak very good English or there was a misunderstanding but, what he might have meant to say is that when you buy a house that is declared as a First Residence of a family, the first 200,000 are tax free and then you have a small add up, depending on the value and number of kids dependent. Now for the seller the tax rate is 7% for the first 15,000 and then 9% for the remaining value. Also that becomes 9% and 11% if you are within big city limits or with Fire Station Service !!! Keep in mind that for empty plots of land (no buildings) the tax free amount is 30,000.
It has to stated that the transaction value could be a lot different (usually higher) than the actual Subjective Value of the property considered by the Tax People, set by the government and revised always upwards on a yearly basis.
In all of the above you must add 3% for the municipality tax, 0.5% for the registrar service, 1.5%-2% for the contracts making lawyer mafia, 1.5% for legal check and your lawyer to be present in the transaction and whatever real estate agency charges that can vary from 1%-2%.
So you see its not that cheap, to make real estate transactions over here although it used to be cheaper to inherit property, however that’s not the case anymore. Here’s a link:
http://www.loupassis.gr/inf-estate-metab-en.jsp
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I followed your advice and bought the FXE 130 Jan 11 Put for $4.30. As of today, I am up 141%. Thanks for a good call!
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Dear Mr Rahemtulla,
Thank your for your past insight as to what I should have done in February. My real question today is after such a decline, what circumstances could/would allow the Euro (FXE) to rally to a possible 1.30?
We have come down so far and with the situation not improving with the PIIGS, etc. why would the Euro rally back that far unless Greece and or Spain was dropped out of the common market?
Hoping you can shed some light on a possible rally.
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Karim, I also followed your advice and purchase the FXE at $6.80. Since the value has doubled, I was wondering if you would go ahead and sell at this point?
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Mark,
Unfortunately, Karim won’t be able to comment on your question, as we are forbidden by the SEC to give out personal investment advice.
Thank you,
Investment U
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Karim, I also followed your advice and purchase the FXE at $6.80. Since the value has doubled, I was wondering if you would go ahead and sell at this point?
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