To The Moon

In fact, the two week window of de-escalation in the conflict has long been priced into capital market movements.

Although a week ago the US and Iran were still trading harsh rhetoric, with the US even threatening to destroy Iranian civilization, after all that saber-rattling you may have noticed that crude oil did not register a new high.

Moreover, the US one-year inflation expectations – which typically spike along with crude oil – and the 10-year Treasury yield – which is most sensitive to US equity moves – remained remarkably calm： 

$美国10年期国债收益率(US10Y.BOND)$ $3倍做空7-10年期国债ETF-Direxion(TYO)$ $20+年以上美国国债ETF-iShares(TLT)$

 In fact, the 10-year Treasury yield pulled back after touching 4.5%, causing the MOVE index (Treasury volatility) to drop, which in turn helped the S&P 500 move higher:

Let’s look at the 10-year Treasury yield over the past week. During the week, the US 10-year yield broke below the key green support line and continued lower. Even though the two countries were trading threats, inflation expectations never strengthened.

That is a signal from the bond market: bond traders probably believe the conflict has entered a phase of temporary de-escalation, and there may be little reason to expect a further sharp escalation.

$美国原油ETF(USO)$ $WTI原油主连 2605(CLmain)$ $小原油主连 2605(QMmain)$ $WTI原油2605(CL2605)$ $两倍做多彭博天然气ETF-ProShares(BOIL)$ $First Trust Natural Gas ETF(FCG)$ $天然气主连 2605(NGmain)$ $微型NQ100指数主连 2606(MNQmain)$ $微型WTI原油主连 2605(MCLmain)$

I have mentioned before that the 4.5% level on the 10-year yield is critically important. Historically, the US stock market has often been unable to withstand a two standard deviation rise in long-term bond yields within one month – and that level is exactly 4.5%. Looking at the comparative trend between the S&P 500 and the 10year yield, history shows that once the 10-year yield breaks above 4.5%, the S&P 500 tends to fall sharply:

So now you understand why Trump was so eager to rattle the sabre at Iran. If the Strait of Hormuz had remained blocked, US stocks could have suffered a deep pullback. The resulting economic damage and negative pressure on Trump’s mid-term elections would have forced him to retaliate militarily against Iran. Fortunately, that scenario did not play out.

Reviewing the strategies I discussed last time, none of the three were triggered – meaning the market remained range-bound over the past week, offering no good trading opportunities:

How to navigate such a volatile market? Building strategies in three directions？

Now that we have another two-week ceasefire window, the most anxiety-provoking asset for everyone is probably crude oil. So, facing this fresh two-week lull, how should we construct our trading strategies?

Let me offer some ideas.

First, we need to analyse a few key points, even though there is a two-week pause between the US and Iran:

1. The ceasefire is the result of mediation, not a unilateral retreat by either side. Therefore, the probability of the conflict reigniting after two weeks is still considerable.

2. Before mediation, both sides had the will and the means to continue fighting, but both had also reached a point where they had to think about how to exit the quagmire. With a little effort from the mediator, it is quite possible that Iran steps back, the US and Iran avoid further military strikes, and the conflict de-escalates from there.

China, Russia, and other Asian nations – all affected by the blockage of the Strait of Hormuz – also have an incentive to participate in mediation. So my judgment is that the conflict is more likely to de-escalate than to suddenly escalate to a more dangerous state than we saw last night. A rough estimate: the probability of de-escalation versus renewed escalation is about 60/40. However, until the real end of the conflict is confirmed, we should avoid overly aggressive one-directional bets. The most likely scenario: in two weeks, Iran keeps the strait open but continues charging transit fees, in exchange for the US staying out of the fight, while Israel continues to exchange fire with Iran unilaterally.

3. Note that Iran is still imposing large transit fees for passage through the Strait of Hormuz. Even though the strait is open, the resulting crude oil premium is unlikely to disappear quickly in the short term. That said, the chance of crude oil challenging its previous high in the next two weeks is very small. At the same time, the downside in the medium term is also limited – we are unlikely to see a complete evaporation of the war premium causing a sharp drop in frontmonth crude contracts.

Alright, based on the above scenario assessment, here is how we can think about constructing our strategies. The first idea is to capture the profit from a shortterm narrowing of the frontmonth to farmonth spread.

Let’s look at the current crude oil futures price structure chart:

A very typical backwardation structure. This structure tells us that the profit from a near-term front-to-far spread narrowing is not very large, because the front-month premium is not excessive. Meanwhile, far-month contracts still embed a significant risk of escalation – as I just said, the possibility of a renewed US-Iran-Israel conflict in two weeks remains high, so the war premium already priced into farmonth contracts is unlikely to be quickly unwound. Therefore, we can only take a short-term bet on the front-to-far spread retracing after the initial de-escalation. Most of that profit has already been realized overnight:

What I show here is just the May-June spread. If you want to increase the return, you could short May and simultaneously go long August. That spread would offer more profit than the chart above. From the current chart, I think the spread narrowing might stop at around $5, offering about $3 of profit potential.

Also note: looking at the continuous crude oil futures chart, the 20-day moving average for WTI futures provides strong support. If the daily close rises above the 20-day MA, the spread-narrowing strategy should be stopped out – that would signal that the daily trend is unlikely to change. With ATR currently around $9, a singleday decline of less than $9 would probably be insufficient to change the daily trend, and that level coincides with the 20-day MA – a resonance.

In terms of timing, if a ceasefire holds for the next two weeks, the fundamental bias for crude oil over the coming week is bearish. If you want to implement a bearish spread arbitrage, act early.

Second, let’s look at the crude oil futures volatility index – it is still at elevated levels. Over the next week at least, this volatility should continue to decline. Therefore, shorting both sides of the crude oil volatility index (i.e., selling a call and selling a put) is a good directional bet.

But here is the question: selling the call – we know we can sell around the previous high of 120. What about the put? What strike is appropriate? Very simple: use the latest price distribution chart for crude oil futures option:

We can see that the largest out-of-the-money call open interest is at 115, 125, and 200. Forget 200 – the margin requirement is too high. So 115 can be considered the upper bound. For puts, the largest outofthemoney put open interest is at 87 and 93, so 87 can be considered the lower strike.

Then, using some technical fitting, take the lower Bollinger Band around 84 as the level for selling the put.

Using the 9-day options on the USO ETF as a proxy, it looks like this:

As long as USO trades between 94 and 152, after 9 days you will collect the premium.

Alright, that’s crude oil. Now let’s look at another opportunity: TLT.

I mentioned earlier that 4.5% on the 10year Treasury yield is a critical threshold because the stock market cannot withstand a twostandarddeviation rise in longterm yields within one month – and that level is 4.5%.

Indeed, the bond market’s decline stopped right at 4.5% on long yields. So, is the blue line I’ve drawn on TLT a shortterm bottom? We could roll sell TLT puts with a strike below 85.45. Use a break below the blue line on TLT, or a sudden escalation of the conflict causing crude oil to spike again, as a stop loss – though that scenario is unlikely.

These are my strategic thoughts in response to the latest market changes. Any better strategy suggestions? Leave me a comment, let’s chat!

  $纳指100ETF(QQQ)$ $纳斯达克(.IXIC)$ $NQ100指数主连 2606(NQmain)$ $微型NQ100指数主连 2606(MNQmain)$ $道琼斯指数主连 2606(YMmain)$ $微型道琼斯指数主连 2606(MYMmain)$ $道琼斯(.DJI)$ $标普500(.SPX)$ $标普500ETF(SPY)$ $SP500指数主连 2606(ESmain)$ $微型SP500指数主连 2606(MESmain)$