Market Participants Confront Dual Threats of Price Volatility Amid Recent Equity Gains

Market Volatility Fluctuates Amid Iran Conflict and Rising Oil Prices

The recent V-shaped recovery in equities following the Iran oil shock has left investors grappling with left and right tail risks, as the tireless AI and semiconductor rally clashes with the gradual drag from higher energy prices. Despite the megacap tech earnings and Federal Reserve meeting failing to dampen investor enthusiasm in the US, the ongoing Iran conflict has oil prices surging once again, casting a shadow of inflation and higher interest rates, particularly in Europe.

The options volatility in the region remains relatively high, with European benchmark indexes exhibiting stubbornly higher volatility compared to their US counterparts. This disparity can be attributed to the sensitivity of European markets to oil and natural gas supply upsets. The rising oil prices have also led to a surge in US gasoline, diesel, and jet fuel prices.

Comparative Volatility Table

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The European equity derivatives market remains in a regime of implied volatility significantly higher than realized, according to Andy Kent, broker at Kyte. This situation could be triggered by a rapid reversal in the market if talks fail and oil prices continue to climb.

The ongoing Iran conflict has had a significant impact on European stocks, with underowned stocks potentially experiencing a sharp rally if the Strait of Hormuz reopens. However, failed talks and another leg higher in oil prices could lead to a rapid reversal in the market.

Despite the challenges posed by the Iran conflict, resilient dividends in the Euro Stoxx 50 have been more resilient to the slide in the underlying spot index. This has been attributed to more muted dealer hedging dynamics, with the Euro Stoxx 50 spot having remained well above key technical levels relevant for auto-callable hedging and diversification within auto-callable issuance.

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The options markets have been relatively calm, with implied volatility and the call skew both well below levels seen earlier in the war. However, oil prices remaining higher are the major stumbling block to a continued rally, according to Florian Ielpo, head of macro at Lombard Odier Investment Managers. The macro conditions are a headwind, with US inflation re-accelerating, euro-zone inflation back above target, and central banks sounding less dovish.

Key Dates

• April 8: Extreme upside momentum in semiconductor stocks began
• May 20: Nvidia Corp.'s earnings will be released, shaping up as the biggest event for tech stocks and the broader market

The Iran war has had a knock-on effect on Euro Stoxx 50 dividends, but the resilient nature of these dividends has helped to mitigate the impact of the conflict. The market is facing higher oil prices, higher yields, and an uncertain timeline regarding the opening of the Strait of Hormuz, leading to a regime of implied volatility significantly higher than realized.