FXE: If the Euro is Toast, Let’s Find A Way to Play With Defined Risk

by Dan November 28, 2011 3:14 pm • Commentary

With the world equity markets screaming today, there is one thing that sticks out to me like a sore thumb, The Euro vs the U.S. Dollar only up 57 bps.   At the very least on a sentiment basis the currency should be trading much better than it is today given the recent 6.5% sell off in 2 weeks.

Technically, (I will use FXE to express my view, the ETF that tracks the Euro vs the Dollar) if it breaks 130 in a meaningful fashion you could see this thing make a quick move back to the 125 support level.

FXE 2 YR chart from Bloomberg


Not A ton new here but this was a great article from the Economist last week that helped reinforce my views


Breaking point

A downturn of such severity will hugely increase the pressures within the zone. Investors will be even less willing to finance banks, as more garden-variety loans to businesses and householders turn bad. As unemployment rises, tax receipts will go down and welfare payments up, making it harder for governments to rein in their deficits and hit the targets they have set, and causing bond markets to question their solvency more pointedly still.

In such circumstances, the chances of a policy error or broader panic increase sharply. The calculations of bond investors, bank depositors and politicians are prone to sudden change. Hopes that the fracture of the euro zone might be averted by far-sighted policymakers could give way to a belief that it is inevitable. Such beliefs, once they take hold, are likely to be self-fulfilling.

How? The drying-up of funding for sovereigns and for banks is a threat to the integrity of the euro, because of the stark divide between debtor and creditor countries within the zone. As late as March 2010, Jean-Claude Trichet, then head of the ECB, boasted that simply belonging to the euro area automatically ensured balance-of-payments financing. It doesn’t look that way now.

Again I am no macro expert, but want make a defined risk bet that the Euro sees lower lows in the weeks to come.  If it can’t get going on a day like today when will it ever without any real news? So here’s the trade:

TRADE: FXE (132.70) Bought the Jan 130/125 Put Spread for 1.23

-Bought 1 FXE Jan12 130 Put for 2.36

-Sold 1 FXE Jan12 125 Put at 1.13

Break-Even on Jan12 Expiration:

Profits btwn 128.77 and 125 make up to 3.77, with max gain of 3.77 at 125 or lower.

Losses btwn 128.77 and 130 lose up to 1.23 and max loss of 1.23 above 130.00