As equity markets continue reaching new peaks, some investors are adhering to a principle: hedge when possible, not just when necessary. In recent weeks, investors have been actively purchasing call options on technology stocks, anticipating upcoming earnings reports which have so far demonstrated robust revenue and healthy outlooks. This has shifted sentiment in the options market from fears of a potential sell-off towards chasing the upward momentum. However, with the conflict involving Iran entering its ninth week, oil supply constraints threaten to exacerbate global inflation, leading some Wall Street strategists to suggest it may be an opportune time to acquire protective measures.
This protection could take the form of direct equity hedges or broader safeguards against rising interest rates. Regarding asset valuation, the forthcoming earnings from tech giants represent a critical juncture for market bulls and bears. Although companies like Microsoft, Meta Platforms, and Amazon are viewed as "safe havens" during volatility due to their strong cash flows, elevated risk-free interest rates are compressing the premium for these highly-valued assets.
As geopolitical risk premiums associated with Iran decline, "conditions for re-engaging in hedging appear more attractive," wrote UBS strategist Kieran Diamond in a client note. He favors buying put option spreads on equities over call spreads on the CBOE Volatility Index (VIX), noting that volatility remains supported even near stock market highs, reflecting persistent uncertainty. "Equity downside appears to offer better convexity than upside volatility hedging," he stated via email, suggesting that from an elevated volatility starting point, a shift to a more risk-averse environment could see stocks fall more sharply than the VIX rises.
Looming over the market is the risk that tightening oil supplies could drive up costs for a wide range of goods, from fuel to food and plastics. The threat of rising inflation—which could keep interest rates higher for longer—is seen as a key factor that might trigger a stock market sell-off once investors look beyond corporate earnings. "From here, the key risk for equities is less a 'headline shock' and more a repricing of longer-duration rates," said Florian Ielpo, Head of Macro Research at Lombard Odier Investment Managers. "As long as corporate earnings hold steady, the rotation into US growth and tech stocks can continue, but this trend becomes vulnerable if oil-driven inflation keeps real yields sticky or pushes them higher."
The shift isn't confined to equity positioning, creating new hedging opportunities. In interest rate markets, investors are increasingly selling volatility as prospects for a ceasefire involving Iran and Israel improve. "They haven't returned to the January lows—when short-volatility trades were at their peak popularity—but we've moved back into that world very quickly," said Gennadiy Goldberg, TD Securities US Rates Strategist, referring to pricing on instruments betting on the movement of the long end of the swap curve a year forward. For rate hedging, traders are increasingly utilizing 30-year swaptions to sell volatility, making it cheaper to hedge against rising long-term rates compared to March levels.
Fund managers are also focusing on longer-term rate protection. "For a diversified portfolio, I believe hedging interest rate volatility makes more sense than simply adding more equity puts," Ielpo noted. "Being long rate volatility is a more direct hedge against an 'interest rate shock' that would impact growth stock valuations, and this strategy tends to provide better diversification when a sell-off is driven by yields rather than pure risk sentiment."
In the near term, equity investors are concentrated on tech earnings, with four giants—Alphabet, Meta Platforms, Microsoft, and Amazon—scheduled to report this week. Thereafter, the situation involving Iran, oil prices, and inflation may dominate the market narrative. "Earnings can support the tech stock story, but the risk is that if energy prices remain elevated, the market could refocus on inflation and real yields," Ielpo concluded. "If that happens, hedging interest rate tail risks could be a more effective protective strategy."
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