Global financial markets, including equities, bonds, commodities, currencies, and crypto, are currently experiencing significant volatility due to several factors, including:
• Geopolitical tensions, particularly the ongoing war between the United States and Israel against Iran, with rising concerns over the potential escalation of the conflict amid uncertainty regarding its duration and resolution.
• Inflation concerns: The notable rise in crude oil prices, which reached around $120 during Monday’s session, with expectations for continued increases, especially if the Strait of Hormuz remains closed, through which approximately 20% of global oil demand passes. This could result in higher inflation rates, potentially prompting central banks worldwide, including the U.S. Federal Reserve, to keep interest rates elevated for longer or even raise them if inflation significantly exceeds the target of 2%.
• Fiscal concerns: Increased military spending, particularly in the United States and Europe, including Germany, France, the UK, and other countries, may strain public finances, which were already experiencing deficits, leading to further widening. Consequently, we have seen broad-based rises in government bond yields in the U.S. and Europe, especially in Germany, France, and the UK, with long-term yields, particularly the 30-year bonds, being the most sensitive to government fiscal policies.
As a result of all the above, most investors, both retail and institutional, consider these risks carefully to protect their investment portfolios from potential losses.
What type of financial market do investors turn to protect their investments from potential losses?
Derivative contracts are one of the most important tools investors use to hedge or reduce risks arising from fluctuations in the prices of financial instruments.
But what are financial derivatives?
Financial derivatives are financial instruments whose value is derived from an underlying asset, such as commodities, stocks, currencies, stock indices, and others. Risk management is one of the most important benefits of derivatives if used correctly.
The main types of financial derivatives include options, futures, over-the-counter forward contracts, swaps, and contracts for differences (CFDs).
Options contracts give the buyer the right, but not the obligation, to buy (Call) or sell (Put) a specific underlying asset at a predetermined price at a specified future time.
An option is also a contract that obliges the seller to buy or sell the underlying asset to or from the buyer at a specific price and time. In return for this obligation, the buyer pays the seller a premium, also known as the option’s cost.
There are two types of options: Call and Put.
Why are financial derivatives important?
Demand for derivatives increases significantly during periods of volatility and uncertainty in financial markets, as is the case currently. If an investor holds an investment portfolio, they have three options:
1- Sell the entire portfolio and exit the market.
2- Retain the portfolio and accept higher risk exposure.
3- Retain the portfolio and use derivatives as a hedging tool to protect the portfolio.
Amid current geopolitical tensions in the Middle East and rising concerns over potential disruptions to global oil supplies, investors are increasingly purchasing options that bet on rising oil prices (Call options). Market data shows that Call option volumes have surpassed Put option volumes, which bet on falling prices, reflecting expectations of possible oil price increases if geopolitical risks worsen or supply disruptions occur.
In contrast, the picture is different in the U.S. equity market, where investors seek protection from potential market declines. Therefore, demand for Put options on the S&P 500 index is rising, exceeding the volumes of Call options betting on index gains. This reflects a cautious approach by investors amid geopolitical and economic uncertainty.
Option premiums are also rising sharply in both markets, indicating that hedging costs are increasing. This is due to higher demand for these financial instruments, which in turn raises implied volatility and the cost of purchasing options.
From a technical perspective, indicators support the continuation of the downward trend for the SPDR ETF tracking the S&P 500 (SPY) in the coming period. The fund shows a bearish crossover between the 20-day and 50-day moving averages, which is a negative technical signal for continued declines. The Relative Strength Index (RSI) is currently around 44, reflecting bearish momentum. Additionally, a bearish MACD crossover is observed between the MACD line and the signal line, further supporting the probability of continued negative momentum for the fund.
Please note that this analysis is provided for informational purposes only and should not be considered as investment advice. All trading involves risk.
