Post Tariff Shock Rally Traders Eye Longer Term Options to Hedge

As the turbulence that characterized April begins to fade, traders are left navigating a more tranquil market environment, though the threat of fresh headline-induced shocks remains. Derivatives experts heading into 2025 largely agree on one point: ongoing volatility-suppressing activity—such as the systematic selling of options by income-generating ETFs and similar funds—should help stabilize markets overall.

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However, they also warn that sudden flare-ups, similar to what happened on August 5, will continue to occur. This perspective seems particularly accurate in light of the market’s reaction to the April 2 tariff announcement, which briefly spiked the Cboe Volatility Index (VIX) before reversing course.

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For investors, the debate about the most effective way to hedge market risk hinges on a choice between two "Greeks": gamma and vega. In simple terms, gamma relates to short-dated options that benefit from quick, sharp intraday market moves, while vega favors longer-dated options that increase in value during broader, more sustained market dislocations.

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During April’s volatility, short-term options reigned supreme due to dramatic intraday and daily swings. But should equities drift back toward last month’s lows, these kinds of dramatic movements may not recur. That’s why some strategists are turning their attention back to longer-dated options—positions that had gained popularity before the April 2 tariff shock. Now, with markets rebounding and recovering early-April losses, there’s a belief that the rally may soon run out of steam.

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Antoine Bracq, head of advisory at Lighthouse Canton, offered a measured view. “We can’t completely rule out a sudden market shock,” he noted, “but we expect a slower repricing driven by softer corporate guidance—essentially a low-volatility bear market.” Additionally, future tariff announcements may not provoke the same market response as before.

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That’s because former President Trump has shown a tendency to shift his tone quickly if the markets react negatively, especially if bond markets start sending distress signals. As a result, investors are exploring strategies that allow them to profit from equity declines without making aggressive bets on a volatility surge.

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However, with markets only one headline away from a sharp downturn, managing hedges actively has become essential. Timing is everything: locking in gains before market sentiment turns again is crucial. Bracq noted that while shorting futures may be the most efficient hedge on paper, executing such a strategy effectively requires perfect timing.

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He instead favors more tactical strategies, such as taking advantage of current implied volatility levels—now with the VIX around 22—by purchasing put spreads with staggered strike prices, such as a December 2025 100%-80% spread.

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Beyond traditional listed options, the over-the-counter (OTC) market is offering more exotic plays. One such instrument gaining traction is the volatility knock-out (VKO) put. These options give investors downside exposure—such as a put on the S&P 500—but automatically expire if realized volatility exceeds a set threshold.

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This feature dramatically lowers their cost—by 40% to 50% compared to standard options—though it also creates the risk of losing protection just when it’s needed most. Because of this, VKOs are often viewed more as speculative instruments than reliable hedges.

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Nevertheless, hedge funds have been active in the VKO space, particularly during recent market selloffs. They’ve used these instruments to bet on simultaneous drops in both equities and volatility. The timing of such trades is critical.

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For example, a VKO position established on April 1 would have likely knocked out soon after, while a six-month position opened on January 1 may still be in play depending on its specific volatility threshold.

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Another hedging avenue for investors involves Quantitative Investment Strategy (QIS) products. These structured offerings combine various rule-based approaches, and given the wide range of outcomes during April’s market swings, a diversified or blended strategy has gained appeal among institutional players.

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In Europe, institutional desks have been spotted buying deep out-of-the-money tail-risk protection. These low-cost, binary-style put spreads offer asymmetric payoff potential. A June Euro Stoxx 50 Index 3,975/3,925 spread, for example, could pay out more than 75 times the initial premium if the market collapses.

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The silver lining for those seeking protection is that hedging costs have fallen significantly—back to levels seen in late March—according to strategists at Barclays. That makes it a relatively affordable time to put on new protection, whether targeting short-term swings or preparing for longer-term drawdowns.

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Strategists at BNP Paribas anticipate that upcoming earnings revisions and valuation compression will lead to a renewed decline in equities, possibly pushing them to revisit 2025 lows. Unlike the rapid selloff seen earlier in April, however, they expect this downturn to be slower and more deliberate. This kind of market behavior is less likely to cause fixed-strike volatility to spike as dramatically.

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As Tanvir Sandhu of Bloomberg Intelligence put it, “Gamma strategies outperformed dramatically during the ‘Liberation Day’ intraday volatility, but the Trump ‘put’—his tendency to support markets—could limit the upside for such hedges if markets fall again.”

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