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How to Short Europe With ETFs as Political Crisis Worsens

Sweta Killa
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After expanding at the fastest pace in a decade, the European economy has lost its momentum this year due to a slowdown in business activity in many parts of the region. This has resulted in a major setback to European Central Bank’s (ECB) plans of winding down its bond-buying stimulus program. The central bank has halved its massive €60 billion per month asset buying program at least until September (read: What European Slowdown? Here Are 4 ETFs Beating S&P 500).

The political chaos, especially in Italy and Spain, has also dented investors’ optimism lately.

Italy Crisis: A Major Risk

The latest round of political development in Italy has escalated the ongoing crisis and brought back memories of the 2011-2012 euro debt crisis that had huge implications on the single currency. This is because Italy, which is without a government since inconclusive national elections on Mar 4, hit another roadblock. after the effort to form the first populist government in coalition with the anti-establishment Five Star Movement and the far-right League has collapsed.

President Sergio Mattarella rejected the choice of a euro-skeptic as finance minister, which could provoke "Italy's exiting of the euro.” The move led to calls for Mattarella’s impeachment and thus, a former International Monetary Fund economist Carlo Cottarelli was officially appointed as an interim Prime Minister to restore political order and end an 11-week deadlock.

The likelihood of another election reignited fears of referendum on its euro membership, raising concerns over the fate of the European financial system and its common currency. However, early reports suggest that Italian populist parties renewed talks to form a government and fresh elections could be avoided. But this again might not turn out to be successful (read: Italy ETFs Plunge on Deepening Political Chaos).

Growing Woes in Spain

The heightened risk of a snap election in Spain also raises questions about the future role of country in the European Union. Prime Minister Mariano Rajoy will face a vote of confidence on Jun 1 in response to a corruption case involving the ruling Popular Party.

Euro Sliding

The crisis in Italy and Spain has been weighing on the euro, which tumbled nearly 8% against the U.S. dollar over the past three weeks (read: Currency Hedged Euro Zone ETFs to Buy After ECB Meet).

Given the worsening politics, the appeal of Europe ETFs has weakened. As a result, investors who are bearish on Europe right now may want to consider a near-term short on the country and its currency. Fortunately, with the advent of ETFs, this is quite easy as there are many options for accomplishing this task. Below, we highlight some of these and the key differences between them:

ProShares UltraShort FTSE Europe EPV

This fund seeks to deliver two times (2x or 200%) the inverse (opposite) of the daily performance of the FTSE Developed Europe All Cap Index. The benchmark measures the performance of large and mid-cap securities of the 15 countries: Austria, Belgium/Luxembourg, Denmark, Finland, France, Germany, Ireland, Italy, the Netherlands, Norway, Portugal, Spain, Sweden, Switzerland and the United Kingdom. The ETF has amassed assets worth $17.9 million and trades in average daily volume of 10,000 shares. It charges 95 bps in annual fees and surged 10.9% in a week (read: Political Woes Grip European Markets: ETFs to Watch).

ProShares Short Euro EUFX

This fund seeks to deliver the inverse return of the daily performance of euro versus the U.S. dollar. It is often overlooked by investors with just $8.4 million in its asset base while volume is light of 1,000 shares per day. It charges 95 bps in annual fees and added 2.3% in the same time period.

ProShares UltraShort Euro ETF EUO

This fund seeks to deliver twice the inverse return of the daily performance of euro versus the U.S. dollar. It has attracted $210.6 million in its asset base and trades in a good volume of 193,000 shares per day. Expense ratio came in at 0.95%. The ETF gained 4.5% in a week (see: all the Inverse currency ETFs here).

Market Vectors Double Short Euro ETN DRR

This ETF tracks the Double Short Euro Index, which is two-times leveraged. This means that 1% weakening of the euro relative to the U.S. dollar would increase the index value by 2% and vice versa. The fund has managed assets of $11.8 million and trades in light volume of 1,000 shares a day. It charges 65 bps in annual fees and is up 3% in the same period.

Bottom Line

As a caveat, investors should note that such products are extremely volatile and suitable only for short-term traders. Additionally, the daily rebalancing—when combined with leverage—may make these products deviate significantly from the expected long-term performance figures.

Still, for ETF investors who are bearish on the European equities and its currency for the near term, any of the above products could make an interesting choice. Clearly, a near-term short could be intriguing for those with high-risk tolerance, and a belief that the “trend is the friend” in this corner of the investing world.

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