Buy Spanish Bank Debt. Let’s say it is Spain that exits the euro zone. This will likely have immediately catastrophic effects on the Spanish financial system. Depositors will attempt to withdraw funds, bond yields will spike, equities will sell off.
But, ultimately, the bonds may be safe. Capital controls will prevent a run on financial assets. Spain will have the flexibility to recapitalize the banks. We saw that bond holders in U.S. financial institutions made out quite well following the bailout.
If another member state of the euro zone exits, one of two scenarios are likely to play out. First, Spain follows and exits shortly afterward. In which case, the trade above pays off. Alternatively, Europe acts to stem defections — by bailing out the Spanish financial system. In which case, owning the bonds of Spanish banks may well be the trade of a lifetime.
Sell Swiss and German equities. A serious slowdown in Europe will hurt Swiss and German exporters. Switzerland, in particular, will have to defend its currency against the possibility of appreciating beyond the point where its exports are competitive. At least for some time, these European powerhouses could see deteriorating economic conditions as their neighbors collapse.
Go Long Volatility in the New Currency. It’s almost a certainty that the new governments will misprice the new currency, setting an exchange rate the market will reject. But its hard to predict whether the currency will move up or down — okay, probably down, but you never know, especially in the early days. So instead put on trades that allow you to profit from the volatility that is almost certain.
Buy Exit Stocks and bonds. When a country devalues its currency and defaults on its debts, outsiders — especially creditors who feel cheated — often predict that economic catastrophe looms. But history doesn’t support this view.
“Dire predictions about economic growth following devaluations are invariably wrong, and most countries quickly recover pre-crisis levels of GDP. If we look at recent devaluations, in almost all cases where countries devalued, they had short, sharp downturns followed by steep, prolonged upturns,” Jonathan Tepper, the Chief Editor of the macroeconomic research group Variant Perception, argues in a recent paper.
If that view is correct, the stock and private debt markets in the devaluing/exiting countries will likely perform very well. Just make sure you don’t take on all the currency risk by buying before the exit. The timing on this one is once you can buy the stocks and bonds with the newly depreciated currency.
Those are your sailing toward Vesuvius trades. Only for the bold.
But keep in mind that its not clear Gaius Plinius Secundus was correct in his assessment of fortune’s favor. He died, apparently from inhaling toxic fumes, without ever returning from the rescue mission. His body wasn’t found until days later, when the soot had finally cleared from the sky.
-By CNBC's John Carney
John on Twitter.