The start of 2026 has been unexpected as President Trump’s foreign policy expansion spurs growth in defense stocks. In the UK, the FTSE 100 is seeing defense firms like BAE Systems, Babcock International, and Rolls Royce rise by 18%, 17%, and 10% respectively by 8 January.
Similarly, in Germany, defense companies like Rheinmetall and MTU Engineering are seeing gains, with Rheinmetall up 18% YTD. The FTSE 100 has increased by over 1% in 2026, although subdued oil prices are limiting the profits of oil majors and retailers, affecting the UK index’s further rise.
Us Defense Stocks Rise
In the US, semiconductor stocks boosted the market at the start of the year, especially with an AI theme extending from last year. Yet, a pivot could occur towards US defense stocks following Trump’s plan to raise defense spending to $1.5 trillion by 2027. Halliburton shows a 12% rise YTD and Lockheed Martin is up nearly 8%.
Though Trump may reduce his rhetoric, his defense plans are likely to impact markets. The initial trading weeks of January set a precedent, pointing towards defense as a major theme for the year.
Given the powerful start for defense stocks in 2026, we should look for ways to ride this momentum. The sharp year-to-date gains in European names like BAE Systems and Rheinmetall suggest continued strength driven by geopolitical headlines. One direct approach is to buy call options on these individual stocks or on a broader aerospace and defense ETF to capture further upside over the next several weeks.
This pattern is reminiscent of what we saw in early 2022, when similar geopolitical events sent defense shares soaring. Rheinmetall, for example, jumped more than 30% in the week following the escalation of the conflict in Ukraine, a historical precedent for the rapid repricing we are seeing now. This past performance indicates the current rally could have significant room to run as long as international tensions remain elevated.
Strategic Investment Opportunities
The current environment of uncertainty is also pushing up implied volatility, making options more expensive. To manage costs, we could use bull call spreads, which cap potential gains but reduce the initial cash outlay. Alternatively, selling out-of-the-money put spreads on strong US names like Lockheed Martin allows us to collect premium by betting that the stocks will not fall below a certain price.
In the US, we are seeing signs of a rotation out of the semiconductor stocks that led the market at the start of the year. The proposed $1.5 trillion defense budget, which is a substantial increase from the approximately $910 billion budget passed for 2025, is a major catalyst for this shift. To play this rotation, we can pair long positions in defense with short positions in the tech sector, perhaps by buying puts on a semiconductor ETF.
The continued weakness in oil prices, with WTI crude struggling to hold above $70 a barrel, is creating a clear drag on oil majors. This underperformance in a major sector is limiting gains for broader indices like the FTSE 100. This presents an opportunity to buy puts on energy sector funds as a way to profit from the subdued price environment.
