Feb. 4, 2025 Option Outlook

To tariff, or not to tariff

Good Morning! On Friday we satisfied the “baby” overvixed signal just to wake up to a 130-point selloff on Monday that bounced significantly.

Through all the fundamental news and volatility, the market has respected the levels that Volland produced for it. Volland was expecting bounds between 5900 and 6100 with peeking on both. We never peeked below 5900 although we came close a couple of times in the overnight, but peeks above 6100 happened twice with subsequent selloffs. When I was on Schwab Network a couple of weeks ago, I revealed a good move for Feb opex was a condor, 5750/5800 on the put side, 6200/6250 on the call side. That has held, even though IV has spiked. My point is, through all the noise, tariffs, FOMC, earnings, etc… these vanna levels are important. Flows matter more than narratives. They have worked well for 0DTE also, although 0DTE has been a lot more violent. What can we expect going forward?

In many ways, 6000 SPX is a crossroads. There is a bit of support underneath, as shown yesterday, and we can see a run to the upside from this week’s vanna.

6100 will continue to be strong resistance, however… and this week’s aggregate vanna isn’t that strong. Aggregate vanna is also not that strong on the all-expiration chart either. It is time for the market to make a decision, either return to the slightly more stable area between 6025 and 6100 or take the plunge towards the 5850-5900 area. Between 5900 and 6025 we can expect a lot of whipsaw and strong moves.

When I was in grad school, I took a keen interest in game theory. Game theory is a logical quantification of incentives and decisions. One principle that I’d want to talk about here is called “cheap talk”. Essentially it is trying to convince someone that you are making a suboptimal choice for an illogical reason while all the while you are making the optimal choice and trying to optimize the outcome for yourself by convincing them to make their own suboptimal choice. That’s what these tariffs are for Trump.

Across all the policies Trump is doing, there is one common thread. Trump is trying to balance the budget without raising taxes. Granted, Trump doesn’t understand all the externalities of his decisions, but through the rhetoric this is the common thread. Tariffs are an attempt to raise revenue from foreign countries. DOGE is trying to cut internal costs. Deporting illegal immigrants is trying to save money on social services. Eliminating DEI programs is trying to save money on something he deems unnecessary. Buying Greenland or taking the Panama Canal are revenue-generating ideas. This is not a sponsorship of these moves, since he is laser focused and is not accounting for all of the economic fallout, but the point is clear. Trump is trying to balance the budget.

Imposing tariffs are a suboptimal decision. He knows it increases inflation, which is an implicit tax on Americans, and he knows it hurts his diplomatic relationships with his allies and trading partners. He is using cheap talk to try to get them to make a suboptimal decision that favors the US. Namely, he’s trying to get more exports or somehow get financial gains from these countries. He’s not trying to use tariffs to control immigration or fentanyl smuggling… if that were true, he would be cooperating with these other countries and striking deals. The threats would be more military based.

Trump is trying to raise revenue. He knows tariffs are suboptimal, so I do not think these trade wars will last long. Expect more good news than bad at this point with regards to tariffs, but on shorter timeframes remain nimble.