The US Secretary of Commerce, Howard Lutnick, spoke about a trade agreement between the US and Japan. In this deal, Japan will finance projects, and the US will decide which projects to support. It includes equity, loans, and loan guarantees, with Japan as the main financier. Additionally, there is a 15% tariff on car production in Japan. Lutnick mentioned that this agreement with Japan could be a model for a future trade deal with the EU. For this to happen, the EU must accept US products and standards. This would encourage the US government to move forward. The goal is to fully open the EU market.

Expected Tariffs Between the US and EU

Tariff expectations between the US and the EU are between 10% and 20%. The goal is to reach an agreement within this range to reduce uncertainty about tariffs, with lower rates preferred. This could create a more stable market environment and ease concerns about trade terms. From these discussions, there is now a clear expectation for EU auto tariffs. The 10-20% range is the common view. Any deal within this range is likely to lower market uncertainty. Traders should prepare for a decrease in implied volatility, especially in sectors that are most affected. The best way to prepare is to look at options on European car manufacturers. In 2023, the EU sent over $60 billion in motor vehicles and parts to the US, making companies like Volkswagen and BMW very responsive to this situation. If a deal is announced within the expected tariff range, selling volatility through strategies like iron condors could be a smart move, as uncertainty would shrink.

Trade Negotiations and Market Volatility

Major trade negotiations often cause spikes in market volatility, which then drop after an agreement is reached. This pattern was seen during the US-China trade talks in 2018 and 2019. We expect a similar situation here, creating opportunities for those ready to benefit from decreasing volatility. The market prefers certainty more than having to deal with unpredictable tariffs. However, we should also prepare for unexpected outcomes. Buying inexpensive, out-of-the-money puts can protect against negotiations breaking down and tariffs going above 20%. On the other hand, if tariffs are surprisingly low—below 10%—there could be a significant market rally, making long call positions on European auto ETFs profitable. The currency market provides another way to express this viewpoint. A favorable deal for Europe, with tariffs at the lower end of the range, would likely strengthen the EUR/USD exchange rate. We can use forex options to prepare for a relief rally in the Euro. Lutnick’s reference to the Japanese financing model hints that negotiations could be complex and lengthy. This means that volatility may not drop immediately but could gradually decrease over several weeks. This timeline benefits options strategies aimed at profiting from time decay. Create your live VT Markets account and start trading now.

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