How To Play An Italian Debt Default

It happened faster than Greece did, and it could be the biggest thing of 2011, with speculators going after Italy and the country's near $2 trillion in debt. Italy is the third largest debtor nation in the world, and is part of the vaunted "PIIGS" group, which includes Greece, Portugal, Italy, Ireland and Spain. A few weeks ago, we finally saw the Greek situation get mostly resolved, except for a few finer points, but the situation is resolved, at least for the time being. There were rumblings last week that Italy could be next, as the yields on 2-year Italian debt jumped from the low 3% to a yield of 3.51% at the end of last week. That is a MASSIVE move in just a week, and it looks as if the Italian situation could be exponentially worse than anything we have seen before, including Lehman Bros. As such, we are seeing U.S. equity futures plunging this morning, down nearly 1%, the Euro is tumbling, and the Swiss franc is seeing record inflows, as the Swiss franc is being seen as one of the few safe havens this morning, along with U.S. debt and the U.S. dollar. Crude oil, and copper are down, but off the lows, and not down as much as one would think given the circumstances of the morning. European leaders are meeting this morning to discuss the situation in Italy, as Italy has the highest debt to GDP ratio in the Eurozone. Once again, it looks as if it will come down to France and Germany having to come to the rescue again, only it will be even harder this time, as Italy's debt dwarfs that of Greece. European leaders should also be considering what to do in the even of the contagion spreading to ultimately to Spain. The Euro Financial Stability Fund is going to have to nearly quadruple in size, to help deal with the massive debt obligations among the "PIIGS." We will have to see EFSF guarantees on nearly all European debt to help steed off the loss of confidence, and even then, that may not be enough. So how to play this? ACTION ITEMS:

Bullish:
Traders who believe that Italy will not default and will ultimately be bailed out might want to consider the following trades:

• Going long the Italian ETF EWI at the height of the crisis in the media may make sense as it will not be long before Italy is bailed out once the news hits the precipice.

• Going long industrials such as Caterpillar CAT or Deere DE could also make sense.

Bearish:
Traders who believe that Italy will ultimately fail may consider an alternate positions:

• Shorting the Italian ETF could prove to be profitable if the country defaults on its debt.

• Shorting the Euro ETF, CurrencyShares Euro Trust FXE could prove to be profitable as the Euro sees outflows based on the contagion issues across the Atlantic.

• Go long a safe haven currency, like the U.S. dollar or the CurrencyShares Swiss Franc Trust FXF could prove to be profitable.

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