Berlin Blues

Richard Croft
October 3, 2011
3 minutes read

After weeks of speculation, parliamentarians in Berlin last week voted to increase German taxpayers’ exposure to worthless Greek sovereign debt by approving a near-doubling of the lending capacity of the eurozone bailout fund. Stock markets around the world rallied early in the week in giddy anticipation of the vote, while happy eurozoners metaphorically high-fived and chest-bumped each other all over the place on the result. All that relief is likely to be as short-lived as it is misplaced.

The fundamental structural problems that led to the current euro-crises have hardly been addressed, let alone solved. At the heart of the problem is the absence of any political mechanism that ensures compliance with the fiscal discipline that member countries of the eurozone swear with a solemn oath to uphold – and that most immediately break.

Absent workable – and enforceable – fiscal controls, richer countries in the union will be trapped in an endless loop of backstopping worthless sovereign debt, no matter which way it’s sliced and diced. (You may recall what happened not too long ago when high-risk sub-prime US mortgage debt was “securitized” and transformed by a lot of financial legerdemain into triple-A rated assets.) Greece will undergo a “controlled” default. Can Portugal be far behind? And after Portugal?

Troubles with the currency union are just one of the plagues (albeit the biggest one) afflicting Europeans at the moment. The region is teetering on the edge of recession, and many of its lesser lights have already sunk into that morbid zone of non-productivity.

European equities have felt the pain, along with most other developed-country equity indexes, illustrated by the MSCI EAFE Index, which has plunged 31.5% since its high earlier this year. Aggressive options traders who believe that global economic conditions, particularly in Europe, have not yet bottomed out might consider bearish plays on a broad, optionable exchange-traded fund with high European exposure, such as the iShares MSCI EAFE Index Fund (CAD-Hedged) (TSX: XIN, Friday’s close $14.78).

The obvious choice is to simply buy say the XIN Dec 15 puts at say 90 cents per share. That price is about half way between the 75 cent bid and $1.05 offered price on this option series. That wide bid offer spread is telling you that there is limited liquidity in this series, and that needs to be taken into consideration before actually entering a position.

Richard Croft
Richard Croft http://www.croftgroup.com/

President, CIO & Portfolio Manager

Croft Financial Group

Richard Croft has been in the securities business since 1975. Since February 1993, Mr. Croft has been licensed as an investment counselor/portfolio manager, operating under the corporate name R. N. Croft Financial Group Inc. Richard has written extensively on utilizing individual stocks, mutual funds and exchangetraded funds within a portfolio model. His work includes nine books and thousands of articles and commentaries for Canada’s largest media channels. In 1998, Richard co‐developed three FPX Indexes geared to average Canadian investors for the National Post. In 2004, he extended that concept to include three RealWorld portfolio indexes, which demonstrate the performance of the FPX portfolio indexes adjusted for real-world costs. He also developed two option writing indexes for the Montreal Exchange, and developed the FundLine methodology, which is a graphic interpretation of portfolio diversification. Richard has also developed a Manager Value Added Index for rating the performance of fund managers on a risk adjusted basis relative to a benchmark. And In 1999, he co-developed a portfolio management system for Charles Schwab Canada. As global portfolio manager who focuses on risk-adjusted performance. Richard believes that performance is not just about return, it is about how that return was achieved.

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