The financial sector continues to get hit, and the fallout is spreading globally. After the U.S. government outlined plans at the start of the week to bail out mortgage giants Fannie Mae and Freddie Mac, woes at Lehman Bros dealt the markets another blow. Lehman, heavily exposed to troubled real-estate investments and seeing its share price steadily sink, announced a fiscal third-quarter loss of $3.9 billion, the largest in its history. The firm also announced plans to spin off its commercial real-estate assets, and sell a majority stake in its asset-management division.

Market participants seem to feel troubles in the U.S. may be reaching an apex, while Europe may be in the early stages of the contagion, sending the dollar higher over the past two months. European Central Bank President Trichet said the financial market strains have made the system more volatile. “Financial market tensions may have made the financial system more vulnerable to the crystallization of pre-existing risks,” he said, in a speech to the European Parliament’s committee for economic and monetary affairs. The eurozone conomy shrank 0.2 percent between March and June, and Trichet said they are “in a trough” amid a weak third quarter (growth is expected to be near zero).

The European Commission announced a cut in their 2008 growth estimate for the eurozone to 1.3 percent from 1.7 percent, and signaled the 2009 forecast may remain cool. Germany was seen sinking into recession. A gradual recovery was seen, with 2010 expected to be a better year than 2009.

We are looking at a massive global slowdown and the potential for lower interest rates in Europe and higher rates in the U.S. next year. If that’s the case, we should see a continued shift into the U.S. dollar and out of the euro. The ECB kept interest rates at a seven-year high of 4.25 percent at its scheduled policy meeting last week, amid concerns about inflation.

The euro hit a low of $1.4074 in early trade. The market may find some psychological support at $1.40, but I think it ultimately should break that level. I think it will work its way down to $1.34, and I am recommending a put spread in the December euro as a good way to play that potential move.

Consider the 1.38/1.3650 put spread, which will cost you about $625 plus commissions, and offer a maximum profit of $1875 if the market moves to my projection of $1.34 - $1.32 by year-end. I’d put two spreads on, and if the market moves to where it’s doubled in value, I’d take profits on one position, and keep the other on.

Feel free to call me with any questions you have about this strategy or others to suit your particular account size and risk tolerance. Ask about our special half-off commissions offer for new clients.

Phillip Streible is a Senior Market Strategist with Lind Plus. He can be reached at 800-803-8037 or via email at pstreible@lind-waldock.com.

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