The European Central bank wants to drive down the value of its currency. Here’s how to profit.
For more than a year, currency strategists have been predicting a decline in the euro. So far, that hasn’t panned out: The European Union’s shared currency has actually gained 4% against the U.S. dollar over the past 12 months. But dramatic action taken by the European Central Bank (ECB) in early June makes a drop in the value of the euro a very strong possibility now. And for U.S. investors, it’s relatively easy to make a play on that prospect.
A falling euro would provide a welcome jolt to the continent’s still-listless recovery: European goods sold abroad would become cheaper, providing a major boost for Eurozone exporters. To help the cause, the ECB in June cut its main interest rate to 0.15% and, for the first time in its history, slashed the rate on bank reserve deposits to–0.1%—in essence charging banks to park their money at the ECB instead of lending it out. Meanwhile, in the U.S., the Federal Reserve has been moving in the opposite direction, tapering its quantitative easing program. Taken together, those moves should translate into a weaker euro against the U.S. dollar, say experts. Morgan Stanley strategist Hans Redeker expects the euro to drop from a recent level of $1.36 to $1.27 by early 2015.
The simplest way to bet on the decline of the euro is through an exchange-traded fund or note. For instance, the ProShares Short Euro ETF produces 100% of the inverse return of the euro’s daily performance against the U.S. dollar. Market Vectors Double Short Euro and ProShares UltraShort Euro both offer twice the inverse return of the euro’s daily moves against the greenback—so if the euro drops by 1%, each will gain 2%. But these so-called inverse and leveraged products are suitable only for short-term bets. Their value resets daily, so over longer periods, returns can differ greatly from what you might expect.
For example, say you make a $100 investment in the UltraShort Euro fund on Monday. On Tuesday the euro rises by 2%, so your ETF loses 4% and is now worth $96. On Wednesday the euro drops by 2%, meaning that the euro is now trading slightly below the level where you bought the ETF. But you’d still be down. That’s because your ETF started Wednesday at $96 and gained 4%, to end at $99.84. Repeat this daily process a few dozen times, and you could see wide distortions between expected and actual returns.
For a longer-term play on a declining euro, consider buying put options on the CurrencyShares Euro Trust, or FXE, an ETF that tracks the value of the euro against the U.S. dollar. Put options give an investor the right to sell the under lying ETF for a fixed price in the future. For example, with the FXE currently trading at $134 a share, you could purchase put options that let you sell the FXE anytime through January 2016 for $134. You’d pay about $5 for the options, requiring the FXE to fall to $129 over the next 18 months to break even. If it fell to $124 a share by then, you’d double your money. With the ECB on your side, it’s a bet worth considering.
A former compensation consultant, Janice Revell has been writing about personal finance since 2000.
This story is from the July 21, 2014 issue of Fortune.