The euro is the official currency of the eurozone and the second largest reserve currency in the world after the United States dollar. Currently, the currency is used by Austria, Belgium, Cyprus, Estonia, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, Malta, the Netherlands, Portugal, Slovakia, Spain, Montenegro, Andorra, Monaco, San Marino and Vatican City.
Short selling the euro is traditionally accomplished by borrowing a set number of euros, with an agreement to repurchase them in the future, and immediately exchanging them for a different currency. When the value of the euro falls relative to the exchanged currency, the cost of repurchasing the euros is lower, and a profit is realized when the trade is closed.
Reasons to Short the Euro
Short-selling the euro is essentially a bet that the euro's value will fall relative to other currencies around the world. The value of currencies can fluctuate due to a variety of different economic and political factors. But there are a few common denominators that often lead to problems for a country and its currency.
The most common reasons for a decline in currency valuation are:
- Debt and Deficits. Countries that run high current account deficits and have a high amount of debt relative to their gross domestic product (GDP) are often targets for currency declines.
- Rising Inflation. Rising inflation rates can marginalize a currency's valuation, while suggesting that the country's currency may be unstable or uncontrollable.
- Interest Rates. Falling interest rates typically have a negative effect on currency valuation, while rising interest rates generally boost currency valuations.
- Uncertainty. Countries without a plan or method to address economic problems can face a currency crisis when traders and investors lose confidence.
How to Short the Euro with ETFs
The most obvious way to short sell the euro is in the currency markets by going short a currency pair like the EUR/USD. The three most common currencies to short the euro against are the U.S. Dollar (USD), Japanese Yen (JPY) and the Swiss Franc (CHF). The EUR/USD currency pair is the most popular trade in the world, but the Swiss Franc and Japanese Yen are widely considered to be safe-havens.
However, the leverage required in the currency markets make it difficult to maintain a long-term position. As a result, international investors with a long-term timeframe are better off using exchange-traded funds (ETFs) that have built-in leverage and pose less risk.
The two most common ETFs to short the euro are:
Investors can also short-sell or purchase put options against ETFs with a long position in the euro. Similar to currency scenario, short selling an ETF involves borrowing shares and immediately selling them with the agreement to repurchase them (ideally at a lower price). Meanwhile, put options are rights to sell the ETF that become more valuable when the price of the security declines.
Here are four ETFs that are long the euro:
- CurrencyShares Euro Trust (NYSE: FXE)
- WisdomTree Dreyfus Euro (NYSE: EU)
- Ultra Euro ProShares (NYSE: ULE)
- Market Vectors Double Long Euro ETN (NYSE: URR)
Key Takeaway Points
- Shorting the euro is traditionally accomplished by borrowing a set number of euros and immediately exchanging them for a different currency with the goal of repurchasing it at a lower relative valuation.
- The easiest way to short sell the euro is by using ETFs with built-in leverage, since the currency markets require significant leverage and expertise.