The euro is the official currency of the eurozone and the second largest reserve currency in the world after the United States dollar. As of 2021, the currency is used by Austria, Belgium, Cyprus, Estonia, Finland, France, Germany, Greece, Ireland, Italy, Latvia, Lithuania, Luxembourg, Malta, the Netherlands, Portugal, Slovakia, Slovenia, Spain, Montenegro, Andorra, Monaco, San Marino, and Vatican City.
Investors may purchase the euro as a way to bet on an improving eurozone economy since the value of the currency is tied to interest rates that tend to rise when the economy is doing well. In contrast, investors may want to short sell the euro as a way to profit from its decline when interest rates are falling and the currency is becoming worthless. Investors may also want to go long or short the euro as a way to hedge their portfolios against currency risks.
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.
In this article, we will take a closer look at how international investors can short sell the euro in order to take advantage of a potential decline in value.
- There are many reasons that investors may want to short sell the euro, including a bet on the decline of the currency or as a way to hedge their portfolio against currency risks.
- Shorting the euro is traditionally accomplished by borrowing a set number of euros and immediately exchanging them for a different currency in hopes of later repurchasing euros at a lower relative valuation.
- Since currency markets require significant leverage and expertise, the easiest way to short sell the euro is by using ETFs with built-in leverage.
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:
- ProShares UltraShort Euro ETF (NYSE: EUO)
- Market Vectors Double Short Euro ETN (NYSE: DDR)
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)
Short Selling Risks
Short selling involves a high level of risk because there's unlimited potential for losses. Whereas a currency's downside is limited to zero, a currency has a potentially unlimited upside that creates the potential for limitless losses. That is, you can lose more than you invest in the first place. Investors should keep these risks in mind when shorting the actual currency while knowing that ultra-short ETFs experience similarly amplified losses when the currency increases in value.