It's Time to Short Europe

 | Nov 21, 2011 | 11:00 AM EST
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The weekend is over and European markets are already headed south, with most major indices already down by about 2.5%.

The underperformance of Europe relative to the U.S. has become particularly pronounced over the past month. While most U.S.-based traders focused on 1220 to 1230 as critical support and resistance levels on the S&P 500, iShares MSCI EAFE Index (EFA) tested and fell through analogous levels on Nov. 9.

So here are a couple of quick trades to profit from the growing spread between the U.S. and Europe.

If you're skeptical of Europe's latest bailout efforts, then an aggressive way to trade is with the ProShares UltraShort MSCI Europe (EPV). This is a leveraged fund designed to deliver twice the inverse performance of the MSCI Europe Index. So, if the benchmark European index falls 2.5% today, EPV is designed to rise 5%.

The MSCI Europe Index itself has only a 17.6% weighting in financials. But when markets go down, the baby goes out with the bathwater. So bad news from Europe will mean good news for this exchange-traded fund, no matter what.

Note that the returns on this ETF are calculated on a daily basis, so it's best suited for a quick swing trade, say, between now and the close of the markets Wednesday. Given the amount of headline risk in the markets, this is a position I'd probably feel comfortable holding over the Thanksgiving holiday weekend.

In theory, a more direct way to bet against European banks is by shorting the iShares MSCI Europe Financials Sector Index Fund (EUFN). This ETF holds a wide range of German, Spanish, Swiss, French and U.K. banks. With the crisis spreading from the periphery to the center, major European banks will be the first dominos to fall in the latest incarnation of the European debt crisis.

Sadly, this is a tiny ETF, with just over $11 million in assets. That means it's probably tough to borrow shares to short -- though several investors have been able to.

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