Speculating in Europe - thru Spain

by Wayne Ferbert on August 1st, 2012

Back on May 18th, I bought some investment exposure to Spain. I used the EWP which is an ETF that has solid options volume. I built the hedge at $20 expiring in October. It is a speculative investment. In fact, I didn’t put any of my clients in to the investment because it was a truly speculative play.

The ride in EWP has been a volatile one. I bought in when EWP was trading at $23.40+ and it dipped to a low of $20. It has recovered back to $22.91 today. So, it is close to break-even.

As you already know following this blog, this kind of investment is only possible because we have it hedged. And this position is definitely hedged. I wouldn’t sleep comfortably if it wasn’t.

The investment premise is not too complicated: I am trying to catch a falling knife. Spain’s economy is in trouble. But when it emerges on the other side (2 years from now maybe??), the investment should pay off with a significant gain.

The Spanish market is down 66%+ since January 1st 2008. When the US markets dipped badly in 2008 & 2009, had you bought the market at any point after it was down only 25%, you would have a nice return today. But the US market declined over 50% from high to low. Trying to predict where that fall would stop was difficult. But the premise was the same: force yourself to invest in the broad market when it dips to new lows. And that is the premise here: catch the knife. The knife might hurt when caught – but will hopefully be useful in the future.

Part of the argument for me was also the ‘relative value’ trade for the Spanish market. It trades at a significant discount to its earnings power. Also, Spain has the lowest debt to GDP ratio among the major countries in Europe that are not named Germany. In fact, according to Forbes.com, the Spanish market trades at the deepest discount of all European countries – including Greece.

To that extent, I like the chance to maybe invest in it some more. Looking at the options, I like the chance to be paid to invest more in Spain on a automated basis. We can do that by selling OTM puts on the EWP. I am targeting the September expirations with a strike price of $21. The premium is around 85 cents – which is roughly 4% for about 2 months of time value. I expect to sell these for about half of my current position in EWP. It will force me to double down and buy more if it dips again.

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