Options market eyes 2022 playbook for Iran war risks

Investors are looking back at 2022 for clues on how the risk from the Iran war unfolds across equity markets. The key concern: an inflation shock that lifts correlations within stock indexes and spurs an extended period of higher volatility. The spike in oil and natural gas is rippling through supply chains, threatening to raise prices not just for gasoline but for a wide range of goods and services. That’s shifted traders’ attention away from single stocks, as macroeconomic worries begin to outweigh more granular themes such as artificial intelligence. This, in turn, has narrowed the volatility premium for individual shares versus the wider S&P 500 Index and shrunk trading volumes.

While the VIX has been more sensitive to drops in the S&P 500, the overall realised moves at the index level have remained muted compared with past crises. The volatility gauge hasn’t closed above 30 points this year, after spending two weeks above that level during the tariff turmoil of last April.

In 2022, the VIX surpassed 30 points periodically following Russia’s invasion of Ukraine and averaged 25.64, more than 6 points above this year’s mean. The S&P 500 fell 19% that year as the Federal Reserve hiked rates multiple times.

“Investors are looking to the 2022 playbook for clues on how the current situation in Iran plays out for markets,” said UBS Group AG derivatives strategist Kieran Diamond. “The risk is an inflation shock, which could drive higher correlations within equity markets, and potentially switch the index volatility regime from fast VIX rises and reversals to one where the VIX floor rises and volatility is sustainably higher.”

At the same time, the Cboe Skew Index of market stress has calmed in recent days, possibly because of the unwinding of hedges as investors became disillusioned with vanilla index puts, according to UBS strategists.