Options tempt traders seeking conflict protection

by David Marino and Mia Gindis

Israel’s air strikes on Iran, followed by the Islamic Republic’s retaliation, rippled through markets Friday, prompting traders to pile into options for protection amid ongoing questions of long the conflict can last.

“The escalation between Israel and Iran, including strikes on nuclear and military targets, marks a turning point in Middle Eastern geopolitics and its ripple effects are already being felt across global markets,” said Tamas Varga, an analyst at energy brokerage PVM. “The Strait of Hormuz — through which 20 million barrels of oil pass daily — now sits on a geopolitical knife’s edge.”

Here are some of the ways traders are positioning for the uncertainty gripping markets:

Oil

As tensions ratcheted up in the days leading up to the attack, some analysts had speculated that a strike could push prices well over $100 a barrel. Traders snapped up bullish call options, a pattern that went into overdrive once Israeli planes started dropping bombs after markets opened Friday in Asia. 

Brent and West Texas Intermediate crude’s implied volatility soared as futures spiked as much as 14%. The panic buying of call options pushed the bullish premium to levels not seen since Russia’s invasion of Ukraine in 2022, with the retaliatory strike drawing additional bidding.

“The way speculators play it is to buy whatever calls are on the screen as fast as possible with no regard for how much they are paying,” said Robert Yawger, director of the energy futures division at Mizuho Securities USA. “Not to mention some speculators are hedging against a short position.”

The ramifications extend beyond flat price, with the shape of the forward curve changing drastically in just a few days, affecting millions of barrels of so-called WTI calendar spread options betting on the difference between delivery months. The unusual “hockey-stick” shape that reflected fears of a glut of oil next year has given way to a backwardated market, where traders pay up for immediate delivery.

Open interest in these options reached a fresh record high Friday, with the equivalent of almost 38 million barrels worth of positions added during the week across a wide range of strikes. 

Gold

The rush into gold during the tariff turmoil of April is recurring to a smaller extent as geopolitics bubble up. The one-month call skew on the SPDR Gold Shares ETF (GLD) has risen to the highest since April 16 as the metal flirts once again with a record high. 

“Any time there is geopolitical escalation investors are going for risk-off investments” such as gold, said Phil Streible, chief market strategist at Blue Line Futures. Investors may expand and move to silver too, according to Streible.

Stocks

The latest flare-up in Middle East tensions had the expected impact on equity volatility markets, with the front-month Cboe Volatility Index future taking a strong bid. 

However, market players have become accustomed to volatility, and moves related to geopolitics tend to fade quickly when de-escalation rhetoric starts. And even with stocks down late on Friday, the drop of more than 1% in the S&P 500 Index will do little to stem the contraction in realized volatility, either on an intraday or closing basis. So long as markets continue to have a playbook for the latest headline risk crisis, owning volatility may continue to disappoint.

“Usually geopolitical events create a knee-jerk reaction that doesn’t have much of a lasting impact, unless there’s some very specific reason,” said Benn Eifert, managing partner and co-chief investment officer at QVR Advisors. The equity volatility reaction was “not that big of a move and it will probably dissipate,” he said.

US Dollar

While the dollar hit a three-year low on Thursday, ahead of this week’s Federal Reserve rate decision options positioning already showed signs that the decline was running out of steam. The attack did little to change that.

One-month implied volatility on the Bloomberg Dollar Spot Index has been trending lower since early April, and risk reversals Friday were the least bearish since April 9. 

The resurgence of geopolitical risk comes on top of domestic unrest in parts of the nation and uncertainty over the impact of US economic and trade policies on the economy.

“The events overnight in the Middle East are diverting attention away from immigration protests in the US, trade policy/wars and the focus on the Senate’s OBBBA,” said Nicky Shiels, head of metals strategy at Geneva-based MKS PAMP SA. 

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