US stocks took a big hit on Tuesday due to increased tension in global politics. President Donald Trump ramped up his focus on acquiring Greenland and threatened new tariffs on US allies. As a result, many investors pulled back on US assets. The Dow Jones Industrial Average fell by 1.4%, while the S&P 500 dropped 1.6%, and the Nasdaq Composite decreased by 1.8%. The VIX index rose above 20, signaling growing uncertainty in the market. Trump plans to impose tariffs starting at 10% on imports from eight NATO countries, with the rate increasing to 25% by June. He also threatened 200% tariffs on French wine. European leaders are discussing possible retaliatory actions, which could make the situation even more tense. The market’s previous optimism has left it vulnerable to sudden changes in policy.

The Euro Strengthens

The Euro gained strength against the US Dollar as bond prices fell sharply. Tech stocks struggled, with Apple and Meta down about 8% for the year and Microsoft down around 6%. In contrast, defensive stocks like Walmart and Procter & Gamble reached new highs, providing some stability. Additionally, small-cap stocks showed strength, with the Russell 2000 outperforming the S&P 500 for the twelfth straight session. On the policy front, Treasury Secretary Scott Bessent noted that Trump might soon announce the next Federal Reserve chair, with a decision expected soon. This will be an important factor for the market. With the VIX over 20, a level not seen since last November, it’s wise to consider buying protection against further declines. This could mean purchasing put options on broad market indices like the SPDR S&P 500 ETF (SPY). Reviewing the volatility during the 2018-2019 trade disputes, the VIX often stayed above 20, indicating that this recent spike might be just the start if tensions worsen. The clear differences between sectors suggest focused strategies. A bearish stance on large-cap tech can be achieved through put options or bear call spreads on the Invesco QQQ Trust (QQQ), since high-valuation stocks are especially at risk from policy shifts. Meanwhile, the strength of defensive names like Walmart and Procter & Gamble suggests that selling cash-secured puts on these stocks could help collect premiums during this upheaval.

Small Cap Outperformance

The strength of small caps is a key trend to monitor. We should consider pairs trades like buying call options on the iShares Russell 2000 ETF (IWM) while also buying put options on the Nasdaq-tracking QQQ. This strategy highlights the success of domestically-focused companies, as recent data shows that firms in the Russell 2000 earn nearly 80% of their revenue domestically, compared to about 60% for the S&P 500. Another area to watch is the US Dollar, which has dropped sharply. Continued tariff threats could dampen foreign demand for US assets. Buying call options on currency-hedged ETFs, particularly those focusing on European stocks, may provide benefits from a weaker dollar. The upcoming meetings in Davos will be crucial in showing if this currency decline continues. Events such as the Davos meetings and the Federal Reserve chair nomination will likely add more volatility. We could employ options straddles or strangles on major indices to benefit from large price movements, regardless of the outcomes of these pivotal events. This approach is a wise way to prepare for the uncertainty expected in the coming weeks. Create your live VT Markets account and start trading now.

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