How spread betters can profit from a Greek tragedy

It was never a good idea: two economies as diverse as Germany and Greece should not have been joined together in one eurozone. The same currency and, by extension, the same ECB interest rate could never suit Europe's powerhouse and its pauper at the same time. So what's in this disintegrating eurozone farce for a spread better?

To see how bad things are, take a look at the price of insuring Greek sovereign debt. In short the credit default swap (CDS) market does just that. Investors wanting to insure themselves against the possibility of a bondblowout by the Greek government can buy a CDS.

The price is quoted in basis points. So if a CDS on, say, $10m of debt costs 50 basis points, in dollar terms that's 0.5% (one basis point is one hundredth of one percent). And 0.5% of $10m is $50,000. So the buyer pays the seller of the CDS $50,000 a year over, say, the next five years.

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Now we turn to Greece. The cost of insuring Greek debt against default is over 2,000 basis points. Just before Lehman Brothers went down, the equivalent figure was nearer 1,400 basis points.

In short, over five years you'd be paying the entire cost of Greek debt to insure it (2,000 basis points equates to 20% of its value). Put another way, the probability of a default that this price implies is over 80%.

Behind Greece, there's Portugal (around 850 basis points) and Spain at around 300 basis points. Across the debt stricken states of Europe premiums just keep on rising as measured by European-wide indices.

Now for the best way to play this carnage: the euro. Sure, the ECB has tentatively raised rates, which would normally bolster the currency. And sure, Spain did just manage to sell off some new debt - albeit on pretty expensive terms. But as Eva Szalay notes in the Wall Street Journal, that is likely to provide "limited respite".

The ECB rate decision, for example, was written off by BNP Paribas as a "sideshow". And given, as my colleague David Stevenson notes in our latest cover story, there are some bright spots emerging across the pond, a short EUR/USD bet looks good at this point.