US shares opened lower on Thursday as risk increased that the Iran war will escalate rather than de-escalate. The conflict is in its fourth week, and markets reacted after Iran said no talks had taken place despite US claims. Iran also said it did not take an administration “15-point” ceasefire deal seriously. The earlier market view was that economic fallout might trigger a policy reversal linked to the “TACO” phrase.

Rising Energy And Rate Pressures

US oil rose nearly 4% and moved towards $94 after dipping below $90 earlier in the week. US Treasury yields rose across the curve from 12-month to 30-year maturities. Reports described the movement of thousands of airborne and ground troops to the region, with talk of a major action after markets close on Friday. Axios reported planning for a “final blow”, with more bombing and attempts to seize Kharg, Abu Musa and Lakan islands near the Strait of Hormuz. The S&P 500 traded down 0.4% to 0.9% on Thursday morning, but was still up about 1% for the week. Key levels cited were 6,550, with further supports at 6,360 and 6,200, while 7,000 was described as resistance. The index was said to be below its 200-day simple moving average. The Fed indicated last week that rates would remain unchanged for the foreseeable future.

Positioning For A Volatility Surge

With talk of a major offensive after markets close on Friday, we should anticipate a significant spike in market volatility. Trading the VIX through futures or options is a direct way to play this uncertainty. A long straddle on the SPY, which profits from a large move in either direction, could also be a prudent strategy ahead of the weekend. The most direct trade is a bullish one on oil, as any escalation threatens to close the Strait of Hormuz. We saw WTI crude futures surge over 35% in just a few months following the start of the Ukraine war in 2022, and a direct conflict involving Iranian oil infrastructure could trigger a similar or even sharper move. Buying call options on WTI futures or energy sector ETFs like XLE positions us for this likely outcome. For the broader market, a defensive stance is warranted as the S&P 500 is struggling below its 200-day moving average. With the Fed signaling no rate cuts due to oil-driven inflation, there is little support for stocks in the near term. We should consider buying put options on the SPX to hedge portfolios or to speculate on a break below the key 6,550 support level. Beyond the major indices, we can look at specific sectors that will react differently to the conflict. Defense contractors in ETFs like ITA are poised to benefit from increased military action, making call options attractive. Conversely, airlines and consumer discretionary stocks will suffer from higher fuel costs and waning consumer confidence, creating opportunities for bearish put strategies. Given the risk of a sharp downturn, hedging long-term equity portfolios is critical right now. Looking back at the market turmoil in early 2022, we remember how quickly geopolitical events can erase gains, underscoring the value of protective puts. Any surprise de-escalation remains a tail risk, but the prevailing evidence points toward preparing for further downside. Create your live VT Markets account and start trading now.

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