How to Short the Euro with Less Risk

12/15/2011 9:45 am EST

Focus: FOREX

John Carter

Author, Mastering the Trade

Shorting the euro will remain the primary trade in world currency markets for 2012, says John Carter, who shares his outlook and a risk-controlled idea for profiting from ongoing euro weakness using options on a popular euro ETF.

Well all eyes seem to be on Europe and the problems there; one day it’s good news and the next day it’s bad news. What does it mean for the euro and the US dollar as well? 

Our guest today is John Carter to talk about that. So, John, let’s talk about the euro first: Where do you see this headed?

It’s pretty crazy, and I wish them the best of luck. In the United States, of course, we have different states that have different issues, but Europe is a completely different animal. 

Italy is not a state. It’s its own country with traditions, with pride. Same with Greece, same with Germany, and the same with everybody else, and that’s the biggest issue they’re facing. 

So, with Italy right now, luckily, they’ve made some changes recently, and that should help, but you see these countries spiraling out of control to the point where there really is an issue where Italy could wake up one day and say “You know what, screw this…we’re going back to our old currency.” 

If that happens, you cannot have the euro without Italy. That’s just it. You can probably survive without Croatia, but there are some key economies over there that they have to keep. 

So you’ve got two things going on there: You’ve got for one, uncertainty, which is going to keep downward pressure on the euro. By the way, the US dollar seasonally at this point typically rallies, and I am actually looking for the dollar index to continue to rally seasonally, but then fundamentally, what’s going on in Europe is you’ve got this quagmire of problems, and the reality of it is, between the United States and Europe, for a while I thought Europe was pulling out of this recession faster. Now it’s clearly evident that Europe is not. 

In fact, they are stalling to the point where it could get pretty nasty, which also bodes well for the dollar and is going to push the euro lower. 

The reality of it is, and the reason why bonds are moving higher so much right now is that if Europe truly goes into a steep recession—which is why bonds are rallying, because they think that could be a distinct possibility—it’s not that China and India will sit there and continue to do well. They will get impacted by that as well. 

So, you’re talking about Europe dragging the entire world down into another double-dip recession kind of a thing. All this points to shorting the euro on rallies.  

It seems that every so often we hear a little bit of a ground swell about how the euro is hurting us and it’s faltering, but usually it’s in bad times and when the economy improves you stop hearing about that. Is this temporary talk, or do you see it as being more serious this time?

This is a bigger thing, and I think the biggest disconnect right now is that a lot of governments really thought that everything that they implemented in 2009 and 2010 was going to save the real estate markets in the US and in Europe and things were going to go back to normal.

Not only are they now saying that that’s not happening, but they see things are going to get worse again.

So, I really think 2012 is going to be a very surprisingly tough year for Europe and for the US. We are going to pull out of it; things will kind of be on the upswing again, whereas, all of the governments around the world thought by now things would be doing well. In reality, it’s going to be closer to the end of 2013. 

There is a lot of stuff that needs to get through the system, and Europe is dealing with that right now.

Finally, the trade on the US dollar index and the euro; what do you suggest?

Well, of course, looking for a stronger dollar, to me the easiest way to play a stronger dollar is to short the euro.  So, you can use euro currency futures, you can use euro spot, the EUR/USD cross, but an easy way to do this too if you don’t want to take a lot of margin risk is use the CurrencyShares Euro Trust (FXE), which is an ETF on the euro. 

So, you can just buy put options a couple of months out on that and just sit on it, and that way you’re only risking the premium and you’re not having to dive in and do all of this crazy leverage stuff if that’s something that you’re not comfortable with.

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