Sell now, ski later

If you're planning a ski trip to Switzerland, my advice is: to wait. Priced in U.S. dollars, the holiday will probably grow cheaper as the season progresses. By next year, it could be a real bargain. As I explained in other Forbes columns, I think the dollar is in the formation stages of a very powerful rally (Forbes, Dec. 4, 1995, and June 17). I am also more bearish on the Swiss franc than at any time since early 1988.

Three years ago, the Swiss franc was trading above SF 1.50 per dollar. Since then, the gap between Swiss and U.S. interest rates has widened and the Swiss economy has hit the rocks, yet the franc is higher at 1.25 to the dollar. This muscular currency is doing a world of bad to its underlying economy. Manufactured exports and tourism have been hit hard. With the exception of Finland, Switzerland has had the worst-performing economy in generally weak Europe for the past six years.

Global investors still think of the Swiss franc as a safe-haven currency, which is why foreign capital pours into the franc with every rumor that Boris Yeltsin has died, or whenever the Democrats look like they'll retake Congress, so the hot money keeps rolling in and unemployment climbs—as consumer confidence droops and real estate values plunge.

An overvalued currency may remain overvalued for a very long time, but for several reasons, time is running out on the overpriced Swiss franc.

First of all, politicians in both Washington and Switzerland would prefer a stronger dollar. A higher dollar would help attract fresh capital flows into U.S. dollar-denominated stocks and bonds, easing pressure on the Federal Reserve to boost interest rates. It would also help stimulate the Swiss economy.

I believe the Swiss monetary authorities will try to kickstart their economy by printing more francs. The economy is so weak that the Swiss have little to fear from domestic inflation.

Another reason to expect a higher dollar/weaker franc: Dollar assets are clearly underweighed in many international portfolios. The dollar's relentless depreciation over the past decade has forced massive liquidations at both the private and public sector levels. There is now a 400-basis point differential between U.S. and Swiss interest rates—you can borrow at 1% in Swiss francs and invest it at 5% in dollars. This "positive carry" is a powerful incentive to buy dollar assets, thus driving up the demand for dollars.

There are many ways to play the falling franc/rising dollar. Here's one that seems attractively priced to me right now: Buy slightly-out-of-the-money dollar call options. Example: At current prices in the over-the-counter market, you can purchase a one-year option to buy $10 million versus the Swiss franc at a rate of SF 1.30 per dollar—only five centimes out of the money. The price of this option is currently just 1% of the contract's face amount, or $100,000.

This is an unusually low price. It's low because the dollar/franc's high/low trading band—the two currencies' volatility—has been compressed during the past year to about 10%, half its average since 1973.

If the Swiss franc, now 1.25 to the dollar, remains below 1.30 for the coming year, the option will expire worthless, and you'll lose your $100,000 premium.

The upside? For every centime above 1.30, the option increases in value by about 0.77% (0.1/1.30) of the nominal amount of the contract, in this example $10 million. That's $77,000 per centime. If the franc reaches 1.313, you earn your premium back. After that, every one centime advance represents a 77% return on your investment. With profits like that, you could take your whole family skiing in Gstaad and still have enough left over to buy a good car.

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