US President Donald Trump said an agreement he reached with Iran would ultimately ensure the Strait of Hormuz is “permanently toll free”, according to the New York Times. He also said that if Iran did not reach a final nuclear accord with the US, Washington would resume military strikes on Tehran or become “the guardian of the Middle East” in exchange for 20% of the region’s revenues.
In markets, oil moved lower after the comments. West Texas Intermediate was down 3.51% on the day at $79.73 at the time of writing.
Market Reaction and Risk Analysis
The initial drop in WTI crude to $79.73 reflects the market pricing in a peaceful outcome and the removal of a significant geopolitical risk premium. Given that the Strait of Hormuz handles over 20% of the world’s daily oil supply, or roughly 21 million barrels, a guarantee of “toll-free” passage is a major bearish signal. We believe this initial reaction may be short-sighted and overlooks the deal’s fragility.
We see the president’s statement as creating a binary event, making options strategies particularly attractive over the next few weeks. The market appears to be under-pricing the risk of the agreement failing, which would trigger the threatened military action or a massive new tax on Middle East oil. We only have to look back to the drone attacks on Saudi facilities in 2019, which caused oil prices to spike nearly 20% in a single day, to see the potential for a violent upside move.
Options Strategies and Sector Hedging
Therefore, we are buying out-of-the-money call options on Brent and WTI futures dated for the next one to three months. These derivatives are now cheaper due to the drop in the underlying oil price and will offer leveraged exposure if tensions resurface. We are also considering long straddles to capitalize on the immense volatility we anticipate, regardless of whether the final price move is up or down.
The CBOE Crude Oil Volatility Index (OVX) has likely fallen on this news, offering a valuable opportunity to buy volatility at a discount. We view this dip as temporary, as the market will soon grapple with the implementation risks and the severe consequences of failure. Any hint of non-compliance or political friction will cause volatility to surge, making these long volatility positions highly profitable.
Beyond oil, we are hedging our bets in related equity sectors. We are looking at put options on major defense contractors as a short-term play against this potential de-escalation. Simultaneously, we are examining options on major tanker and shipping indices, which now face a dramatically altered risk profile in the world’s most critical energy chokepoint.
