The new tariff agreement between the European Union (EU) and the United States introduces a 15% base tariff on most EU exports, including cars, semiconductors, and pharmaceuticals. In return, the EU will buy $750 billion worth of U.S. energy and military equipment. While some European leaders welcome the stability this deal may bring, there are worries about its fit with the “America First” trade policy. The final details of the agreement are still being worked out and have not been completed.

Market Responses

In the stock market, major European indices reacted differently. The German DAX experienced the largest drop at 1.13%. France’s CAC and the UK’s FTSE 100 both decreased by 0.43%, while Spain’s Ibex fell by 0.12%. Italy’s FTSE MIB remained unchanged. We think the market’s mixed and negative reaction indicates that the agreement may create more uncertainty than it solves. The unresolved terms mean there will be headline risk, leading to possibly undervalued implied volatility. Derivative traders should prepare for wider price swings across major European indices. The sharp decline in the German index reflects market worries about the new terms, especially for its export-driven economy. With nearly 500,000 German cars set to be exported to the U.S. in 2023, a 15% tariff threatens corporate earnings. This situation presents a clear opportunity to buy put options on the DAX or an ETF that tracks European automakers.

Volatility And Trading Strategies

Historically, trade negotiations, such as the U.S.-China disputes from 2018-2019, led to significant spikes in volatility indices. The Euro Stoxx 50 Volatility Index (VSTOXX) is currently around 15, which is low compared to historical market stress levels. We expect this number to rise, making long volatility positions, like straddles on the CAC or Euro Stoxx 50, appealing due to the upcoming uncertainty. The flat performance of the Italian market suggests it might be seen as more insulated. However, the extensive tariffs on semiconductors and pharmaceuticals will likely create challenges for Italy too. The EU’s large energy purchases could also lead to inflation, applying pressure on European companies. As a result, we recommend selling out-of-the-money call spreads on broader indices, as this strategy could benefit from a stable or declining market. Create your live VT Markets account and start trading now.

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