Quant analytics: PIIGS Mean Reversion Trade

(Last Updated On: April 11, 2011)

PIIGS Mean Reversion TradeSpain, Italy, and Greece are some of the world’s best performing stock markets year to date. Recently these PIIGS economies have started showing some serious political and economic problems. Is a mean reversion trade due? –Short the Euro (FXE) its all a house of cards…France will tank along with the rest of them… they will default… how much is the question – 20 cents on the dollar 30 cents–. Coutnries don’t collapse like “Lehman Brothers”, especially single currency countries. Speculation on the Euro has sent many traders rushing to cover their short positions recently. I agree that the Euro is currently overvalued. It should trade around the 1.30 range instead of 1.40 but it’s not like the US economy has convinced economists about its recovery either. What will happen after the QE stops is still a question that remains to be adressed. Furthermore, given the fact that ECB will raise rates before Fed does, this will strenghten the Euro even further. (of course this will also put more pressure on the PIIGS economies) Having said that, I still believe that the Euro might overshoot to a higher level than its recent highs. I wouldn’t act so fast as to short the Euro right now. But if you are convinced that the european debt crisis will lead all the PIIGS to default on their obligations, then a better trading strategy will be to go long in the UltraShort Euro Exchange-Traded Fund (NYSE:EUO). By doing this you will “double short” the Euro through this reverse ETF– what you said is interesting because I would be bullish on the EUR vs USD, primarily because of EUR raising rates before the Fed (anything vs. USD seems good at this point in time).
The PIIGS issue seems to be more of a medium term issue and is unlikely to play out today or tomorrow. But overall, if my duration is anything more than 6 months, shorting the EUR ETF would seem to be a good strategy.
It will be interesting to see rising inflation expectations affect the Fed and ECB’s interest rate policy, especially after Australia and China have raised interest rates multiple times
From a Linked In group discussion


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