The European Union is reportedly prepared to implement trade retaliation measures against the United States, even if a deal appears near. This is in response to the possibility of the US increasing tariffs on EU goods, according to two diplomats cited in a report.
Retaliatory Measures By The EU
The EU has developed retaliatory measures designed for rapid deployment against the US. These measures do not require extended discussions among member states and could quickly take effect. The agreement allows for tariffs of up to 30% on €93 billion worth of US goods, potentially starting from 7 August.
Sources indicate that these countermeasures would be put on hold if a deal with the US is reached by 1 August. This strategy aims to ensure a rapid response capability should negotiations between the EU and the US fail.
We see the approaching August 1st deadline as a clear catalyst for market volatility. The situation presents a binary outcome: a relief rally if a deal is struck, or a sharp, negative reaction if negotiations fall through. This setup makes holding long volatility positions an attractive strategy in the coming weeks.
Given the market’s current calm, with the CBOE Volatility Index (VIX) recently trading under the 15 mark, options are relatively inexpensive. We believe this represents complacency in the face of a significant geopolitical risk. Buying call options on the VIX or its European equivalent, the VSTOXX, offers a direct way to profit if the report’s scenario of swift retaliation unfolds.
Positioning For Volatility
We are also positioning for a potential downturn in equity markets using index options. The mention of tariffs on €93 billion worth of goods would directly impact corporate profits, justifying put options on the S&P 500 and the Euro Stoxx 50. This serves as a direct hedge against the tariff risk outlined in the diplomatic sources’ comments.
Historically, markets react poorly to such escalations, as seen during the 2018 US-China trade war which triggered several periods of steep market declines. The market’s memory appears short, and we believe it is underpricing the potential for a negative surprise. The agreement to fast-track countermeasures without lengthy discussion increases the odds of a sudden market shock.
The currency market, specifically the EUR/USD pair, will also be sensitive to this deadline. A failure to secure a deal would likely weigh on the euro as investors price in economic damage to the bloc. We are therefore considering options strategies that would benefit from a decline in the EUR/USD exchange rate.
Finally, we are looking at sector-specific derivatives. European automakers and American agricultural and spirits exporters are likely targets, as they have been in past disputes. Buying put options on ETFs representing these vulnerable sectors could provide a more targeted way to trade on the outcome.
