US stock markets faced a bumpy ride on Tuesday due to escalating tensions between the US and Iran. This volatility followed President Trump’s demand for ‘unconditional surrender’ on Truth Social. As the day progressed, more selling was seen, wiping out the gains from Monday’s rally. The S&P 500 dropped by 0.8%, losing 50 points. The Nasdaq fell by 0.9%, while the Russell 2000 decreased by 1.0%. The Dow Jones Industrial Average (DJIA) slid down by 0.7%, and Canada’s Toronto TSX dipped by 0.2%.

Market Sentiment Shifts

This decline comes after a relatively positive Monday, where gains gave an impression of stability after a rocky start to the month. However, Tuesday’s trading showed that optimism is still fragile. Traders quickly reacted to the President’s comments, which heightened tensions. The unexpected timing and tone of the statement shifted market sentiment from cautious optimism to a more defensive approach. The broad decline in major indices reflects greater awareness of geopolitical risks. The drop in small-cap stocks, evident in the Russell 2000’s performance, suggests hesitance toward investing in domestically focused equities. This kind of divergence often indicates a preference for safer investments. VIX futures, a measure of expected market volatility, rose during the last hour of trading. This late movement signals that traders are remaining cautious in anticipation of more geopolitical news. We noticed increased trading volume as the session closed, indicating that activity was not just a short-term reaction but involved major portfolio adjustments. There are few signs of buyers confidently entering the market. Looking at pricing, some weekly index options now show higher implied volatilities, particularly for expiry dates over the next two Fridays. This generally means a demand for protection, which tends to stay elevated unless volatility turns around sharply. We’re not seeing quick sell-offs that vanish in a day; there is established momentum, and traders are cautious.

Shifting Market Dynamics

Powell’s recent comments, which initially appeared supportive, faded from view as geopolitical risks resurfaced. The rates market briefly reacted to stress in stocks, with the 2-year Treasury yield declining slightly. However, these moves were moderate, implying that bond traders don’t predict a chaotic unwind just yet. In the derivatives market, a notable change in SPX options stood out. The price of put options increased compared to calls at the same strike. This shift rarely happens by chance; it indicates more hedging activity. When demand for downside protection rises across various expiry dates, it can lead to stricter hedging requirements for dealers, potentially increasing short-term volatility unless balanced by strong inflows. We also monitored ETF options related to high-yield credit closely. There were significant purchases of downside puts early in the day, indicating expectations of wider credit spreads or a lack of confidence in higher-risk corporate bonds. This aligns with the overall market weakness: no single theme dominated; risk sentiment was down across the board. Next week’s CPI report is set to create additional volatility, not only due to central bank uncertainties but also heightened geopolitical tensions. Any surprises—positive or negative—could have more significant effects, especially if they coincide with further political statements. To navigate these changes, we must keep track of key technical levels which broke late on Tuesday. S&P futures dropped below their 20-day moving average for the first time in over three weeks. While this isn’t always a major signal by itself, combined with increasing trading volume and a rise in short-term put open interest, it suggests several areas of potential pressure. Options activity in large-cap tech stocks also increased, with many short-term bearish bets being placed. These weren’t small trades, and some occurred repeatedly in short intervals, suggesting either repositioning of hedges or strong directional bets from significant market players. While this doesn’t necessarily indicate a long-term decline, it signals rising concerns about sector-specific risks and reinforces broader market trends. To stay responsive during this phase, we believe it’s essential to adjust positions based on volatility. This involves monitoring gamma exposure on key expiry dates, refining strategies that blend conviction with flexibility, and staying alert to repricing across related assets. While timing is uncertain, flows indicate where pressure is mounting. Create your live VT Markets account and start trading now.

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