President Donald Trump on Wednesday announced a new set of tariffs that sent global markets tumbling. We’ll use options to hedge further market turmoil. It is true that the United States currently faces asymmetric tariffs and trade policies, which have contributed to a significant trade deficit. Establishing fair trade practices and tariffs is essential. However, supply chains cannot pivot on a dime. Reestablishing domestic manufacturing capabilities is a lengthy and costly process, so market participants likely anticipated that the administration would seek to renegotiate in a manner that provides more runway for businesses to adjust. But that’s not what happened. The S & P 500 dropped 4%, on pace for its worst day in more than two years. Tariffs are expected to increase prices for imported goods, which could lead to higher inflation and impact U.S. consumers and manufacturers. However, the inflationary impact may be a one-time event if the trade war doesn’t escalate further, a point Federal Reserve Chair Jerome Powell made during his most recent post-FOMC remarks. Goldman Sachs raised its forecast risk of recession only a couple of days ago. Their probability assessment is likely higher today. Under normal circumstances, when a significant economic release occurs, options prices rise ahead of the event but subsequently decline as the news breaks. “Sell the news” tends to be the mantra for the options markets when the facts become known. ‘Ongoing saga’ The challenge, however, is that these tariffs are much larger than most traders anticipated. Consequently, there is now concern that this will be an ongoing saga as countries either relent or retaliate. The first outcome would be a massive win for the United States, while the second would likely be far uglier. Combining a global trade war with anemic economic growth in much of the developed world creates a scenario that rarely has a happy ending. The Smoot-Hawley tariffs of the 1930s are widely believed to have worsened the Depression, and some pundits have drawn parallels to that era overnight. I expect a “higher for longer” scenario to be the reality for options premia (implied volatility) in the coming days and weeks. Additionally, I would like to point out that the S & P 500 fell more than 20% from peak to trough in 2022 during the Fed’s rate hiking cycle and declined around 20% in the fourth quarter of 2018. These events could be equally as economically impactful. If our trading counterparties respond to our unilateral action with an olive branch and a desire to negotiate in good faith, volatility will decrease, and the markets will stabilize. However, it’s worth noting that even if that’s the most rational policy, it’s not necessarily the one they will adopt. Some politicians abroad may feel it could weaken their political standing domestically if their respective electorates perceive them as kowtowing to Trump. Therefore, although premia remain elevated, hedging may be the prudent course. The trade Using put spreads helps mitigate costs. Ideally, spend around 25% of the difference between the strikes or less and choose out-of-the-money strikes. This trade involving the SPDR S & P 500 Trust (SPY) serves as “disaster protection.” Buying at-the-money options is likely to be quite expensive. The SPY spread below was priced at approximately $6.00 as of Wednesday’s close. Buy SPY May 30 $550 put Sell SPY May 30 $500 put Trade well. Get Your Ticket to Pro LIVE Join us at the New York Stock Exchange! Uncertain markets? Gain an edge with CNBC Pro LIVE , an exclusive, inaugural event at the historic New York Stock Exchange. In today’s dynamic financial landscape, access to expert insights is paramount. 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A stock market hedge for investors to use if this turns into a tit-for-tat global trade war
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