Trader's Dilemma: Middle East War, Oil Prices Soar, but US Stocks Just Won't Fall

The situation in the Middle East remains tense, and U.S. stock options traders are facing a volatility dilemma.

After the U.S. launched attacks on Iran's nuclear facilities, tensions in the Middle East escalated further. According to reports from CCTV News and Global Network, on June 21 local time, U.S. President Trump posted on his social media platform "Truth Social" that the U.S. had completed attacks on three Iranian nuclear facilities in Fordow, Natanz, and Isfahan, stating that "Iran's Fordow (nuclear facility) no longer exists."

Despite the escalating geopolitical risks, the U.S. stock market has reacted calmly. Since Israel launched airstrikes on Iran more than a week ago, oil prices have surged by 11%, and crude oil volatility has reached its highest level since the Russia-Ukraine conflict in 2022; in contrast, the S&P 500 index has only dropped by 1.3%.

This has put options traders in a dilemma: should they sell volatility, risking unexpected shocks from escalating conflicts; or buy volatility, but continue to lose premium due to limited actual market fluctuations?

UBS Global Wealth Management strategist Anthi Tsouvali commented:

"The market will react, but the stock market's response may still be moderate. Investors must also consider the impact of rising oil prices on inflation."

The Options Market Shows a Complex Pattern

In the current environment, volatility trading in the options market faces unique challenges. On one hand, implied volatility has significantly decreased from its peak two months ago. On the other hand, premiums are not cheap.

Bloomberg data shows that as of last Friday, the Chicago Board Options Exchange Volatility Index (VIX) is at its highest level relative to the actual volatility of the S&P 500 since April, indicating that options prices remain relatively expensive.

Gareth Ryan, founder and managing director of investment firm IUR Capital, pointed out:

"Selling volatility currently carries significant risks, as any volatility event could lead to substantial losses; while buying volatility requires continuous premium payments, with uncertain returns."

Meanwhile, the options market's sensitivity to headline risk has also decreased.

Earlier, the tariff policy announced on April 2 triggered a "gamma squeeze" (a phenomenon where the sensitivity of options prices to changes in the underlying asset price changes dramatically when the asset price fluctuates rapidly), resulting in substantial profits for some volatility structures.

However, the profit potential for similar events has significantly weakened now. Market trends indicate that traders are becoming cautious in their response to the July 9 "tariff deadline" (the end date for the 90-day suspension of reciprocal tariffs).

Market Concerns Intensify, Trading Strategies Shift to Short-Term

J.P. Morgan strategists noted that after multiple policy shifts by Trump, investors have begun to feel fatigued, and the July 9 tariff deadline may be postponed, creating further uncertainty and making firm trading difficult.

Options market data shows that trading has begun to shift towards contracts with near-term expirations: the trading volume of S&P 500 options has decreased since May, with zero-day-to-expiration contracts reaching a new high of 59%. There are signs that stock traders' concerns have intensified. The Cboe VVIX index (a measure of VIX volatility) has also risen to the high end of its range over the past year, indicating an increased demand for hedging against extreme volatility in the market.

Meanwhile, some investors are reducing risk exposure through strategies such as "stock substitutes," using options instead of direct stock holdings. It has been reported that an anonymous trader recently invested up to $3 billion in call options expiring in 2027, covering several large-cap U.S. companies, demonstrating confidence in a long-term market uptrend.

Cross-asset trading has also become a hotspot. The implied volatility of the U.S. oil fund relative to the SPDR S&P 500 ETF has risen to its highest level since the onset of the pandemic in 2020, prompting banks to engage in more binary mixed trading between oil and stocks.

Alexandre Isaaz, head of equity derivatives sales and structured business at Bank of America EMEA, stated:

"In such a geopolitical and macro environment, hybrid products become a natural tool, with recent activities around oil themes hedging against stocks (and foreign exchange) through directional and volatility trading."