Dow Jones futures rose 0.82% to near 50,100 in European trading on Monday, while S&P 500 futures added 0.93% above 7,550 and Nasdaq 100 futures climbed 1.38% above 29,950. Volumes were expected to be light, with US cash markets shut for the Memorial Day bank holiday. Gains came as talk of a potential US-Iran agreement eased concerns over inflation and the risk of further Federal Reserve tightening.
Axios reported that the two sides were close to an agreement featuring a 60-day ceasefire extension, with the Strait of Hormuz reopened and Iran clearing mines to allow shipping to move freely, in return for the US lifting its blockade on Iranian ports. Reuters, citing Iran’s Tasnim news agency, said Washington was still blocking clauses tied to the release of frozen Iranian assets, while Secretary of State Marco Rubio told the New York Times a comprehensive nuclear deal could not be rushed. Rate expectations stayed sensitive to energy-driven inflation: CME FedWatch showed a near 41.0% chance of a 25-basis-point Fed hike by year-end, after last week’s gains of 2.13% for the Dow, alongside 0.88% for the S&P 500 and 0.45% for the Nasdaq 100, as attention turns to PCE, GDP and income-and-spending data plus earnings from Zscaler, Salesforce and Dell Technologies.
Market Volatility and Strategic Option Plays
With optimism surrounding a potential US-Iran deal, we are seeing a decrease in market volatility. The VIX, a key measure of expected market turbulence, has recently fallen below 14, a significant drop from levels near 18 just a few weeks ago when Middle East tensions were higher. We should consider selling options to collect premium, taking advantage of this lower implied volatility environment.
The biggest impact of a deal would be on energy prices, as reopening the Strait of Hormuz affects about a fifth of the world’s daily oil supply. We are positioning for a drop in crude oil prices from their current perch above $95 per barrel by buying puts on energy sector ETFs like the XLE or considering call options on transportation stocks, which benefit from lower fuel costs. Historically, even temporary resolutions in this region, like the easing of tensions in 2019, have led to sharp, short-term drops in oil prices.
Inflation Implications and Hedge Considerations
This geopolitical development directly counters the inflation narrative that has been worrying markets. The latest Personal Consumption Expenditures (PCE) price index reading of 3.1% has kept the Federal Reserve cautious, but a significant drop in energy costs could quickly reduce the 41% probability of another rate hike this year. We believe this makes call options on interest-rate sensitive indices like the Nasdaq 100 attractive.
However, the deal is not yet finalized, with reports indicating potential roadblocks from both sides. To manage this uncertainty, we are buying cheap, out-of-the-money puts on the S&P 500 as a hedge. Should the agreement fall apart, we anticipate a rapid return of risk aversion that would make this protection highly valuable.
Looking ahead to the end of the month, earnings from tech giants like Salesforce and Dell will be critical. We are preparing to use options strategies like straddles to play potential large price swings following these reports. The upcoming PCE inflation and GDP data will also be pivotal, potentially confirming the disinflationary trend and giving us more confidence in our bullish positions.
