These "PIIGS" Aren't Flying... But Here's An Investment That Will
by Karim Rahemtulla, Advisory Panelist
Tuesday, February 9, 2010: Issue #1193
Spending: Out of control... Budget deficits: Surging... Real estate: Sinking like a rock...
Welcome to America, right?
Well, yes. But no. I'm actually talking about the so-called "PIIGS" - Portugal, Ireland, Italy, Greece and Spain. Back in December, I headed to Baltimore to give an interview about the trouble facing these countries as a result of the issues I just mentioned.
The investment "call to action?" Play the debacle by betting on downside for the euro currency.
Presto... the euro has tanked about 10% since that time - a huge move in the currency world. But I think it has even further to go - and more profit to dish out...
"PIIGing" Out... And Paying the Price
The PIIGS are choking on their own mud.
We've seen the global markets tank recently, partly due to a deepening economic crisis in Greece. Having borrowed massively in order to fund its socialist public spending agenda, the lack of discipline has finally caught up with them. The coffers have run dry and the country's budget deficit-to-GDP ratio is significantly higher than the low single-digit level mandated by the Eurozone. But Greece isn't alone...
Its fellow PIIGS are headed in the same direction, as tax revenue has collapsed, economic growth is stunted and the bills are due. With Greece's sovereign debt already downgraded, the others are in jeopardy, too.
Sounds very much like what we're going through in the United States, doesn't it? One basket case at a time, however!
And the fall guy for this crisis?
Crank Up the Printing Presses
Since it's the single common denominator for all these countries, the euro is bearing the brunt of the mess.
On a stand-alone basis, the euro is already overvalued vis-a-vis the U.S. dollar on a purchasing power basis. Question is: Does the Eurozone have the fortitude to stand up in the face of forced devaluation? Probably not, since standing pat would likely mean a full-on economic collapse of one of the member nations, or more - a scenario that would threaten the entire Eurozone pact.
Instead, the solution will most likely be many central banks' go-to option: Print more euros and bail the weaker sisters - a move that the market is currently foretelling.
So how can you play the scenario of the euro falling - and possibly heading towards parity with the greenback? (Bearing in mind, of course, that the United States has problems of its own that are hardly small.)
LEAPS: The Best Way to Play Euro Downside
If you're going to bet against the euro, you need to have my wits about you. That means not putting yourself in a position where you either have limitless risk, or need to invest too much in order to make a decent profit.
An excellent way to avoid this is by buying LEAP put options on the CurrencyShares Euro Trust (NYSE: FXE) - the ETF that represents the euro, which substantially limits your risk.
To refresh your memory, LEAPS are long-dated options, which give you the right (but not the obligation) to control the underlying shares.
So if the FXE moves lower, sooner rather than later, the LEAPS will rocket higher. If the FXE moves down gradually, you can still profit because these options give you plenty of time to wait for the move. And because FXE trades on the NYSE like a regular stock, you don't need to use a currency futures account. It all can be done from your regular options account.
Furthermore, your entire risk is only what you invest in the trade - no one's going to come knocking at your door, asking you to pony up more cash. If you sold FXE shares short, however, your risk would be potentially limitless. So why bother when LEAPS are much more attractive?
Here's my advice:
~ Pick a level that you think the euro will go to and pull up the options chain for FXE puts. For example, a trade on the euro falling to $1.30 (it's at $1.36 today) would cost about $7 per contract ($700 per 100 shares under control), requiring a move to $1.24 within two years to break even. A move to parity would net you a nice gain of around four times your investment.