Geopolitical Risk

Geopolitical Risk for Trading

When to Activate

• Assessing the market impact of geopolitical events (conflicts, sanctions, elections)
• Building scenario analysis frameworks for geopolitical uncertainty
• Trading supply chain disruptions caused by geopolitical events
• Evaluating safe haven flows and war premiums in commodities
• Analyzing sanctions regimes and their impact on markets and capital flows

Core Concepts

Geopolitical Risk Measurement

GPR Index (Caldara & Iacoviello):

• Text-based index counting geopolitical risk references in major newspapers
• Two components: geopolitical threats (forward-looking) and geopolitical acts (realized events)
• Historical average: ~100; spikes above 200 = elevated risk (9/11, Iraq War, Ukraine invasion)
• Correlation with assets: negative for equities (risk-off), positive for gold and oil
• Limitations: media attention bias, does not quantify severity or duration

Other Risk Measures:

• Political risk indices — Eurasia Group, EIU country risk scores
• Implied volatility — VIX, OVX (oil), GVZ (gold) spike during geopolitical events
• CDS spreads — sovereign CDS prices reflect country-specific political risk
• Safe haven flows — price of gold, UST, JPY, CHF as proxy for risk appetite
• Shipping insurance rates — war risk premiums for specific shipping lanes

Scenario Analysis Framework

Structured Approach:

Step 1: Define the geopolitical event or risk
Step 2: Identify plausible scenarios (3-5, from best to worst case)
Step 3: Assign probability to each scenario
Step 4: Map market impact per scenario across asset classes
Step 5: Calculate expected impact (probability-weighted)
Step 6: Identify asymmetries (which scenario is most underpriced?)
Step 7: Design trades that profit from underpriced scenarios

Scenario structure:
- Base case (40-60%): most likely outcome, usually partially priced
- Bull case (15-25%): de-escalation, resolution
- Bear case (15-25%): escalation, widening conflict
- Tail case (5-10%): extreme outcome, major market dislocation

Key Principles:

• Markets price geopolitical risk inefficiently — tend to under-react to slowly building risks, over-react to sudden events
• "Buy the invasion, sell the war" — markets often bottom on the event itself and recover
• Duration matters more than intensity — short sharp events are absorbed quickly; prolonged uncertainty drags on growth
• Second-order effects are often more important than direct impact (sanctions -> supply chains -> inflation)

Supply Chain Disruption Trading

Critical Chokepoints:

Strait of Hormuz:
- 20% of global oil supply transits through
- Iran-related risk: closure would spike oil $30-50/bbl
- Insurance costs for tankers reflect real-time risk assessment

Strait of Malacca:
- 25% of global trade by value
- Choke point for oil shipments to China, Japan, Korea
- South China Sea tensions affect risk pricing

Suez Canal:
- 12% of global trade
- 2021 Ever Given blockage: short-term disruption, limited price impact
- Houthi attacks (2024): Red Sea rerouting added 10-14 days transit, raised shipping costs 5-10x

Taiwan Strait:
- 90%+ of advanced semiconductor manufacturing
- TSMC disruption would be catastrophic for global tech supply chains
- Most consequential geopolitical risk for markets

Commodity Supply Disruption Framework:

Impact severity = f(market share, substitutability, inventory buffer, duration)

High impact (>10% price move expected):
- Major producer sanctions (Russia oil/gas, Iran)
- Chokepoint closure (Hormuz, Malacca)
- Multi-month conflict in producing region

Medium impact (5-10% price move):
- Temporary export restrictions (Indonesia nickel, India wheat)
- Targeted sanctions on specific companies
- Regional conflict near production areas

Low impact ( global chip shortage -> 50%+ decline in semis stocks
- Technology: every major tech company dependent on TSMC for advanced chips
- Shipping: South China Sea disruption affects 25% of global trade
- FX: USD rally (safe haven), CNY collapse, JPY mixed (safe haven vs regional risk)
- Commodities: industrial metals crash (demand destruction), energy spike (supply routes)

Portfolio preparation:
- Diversify semiconductor exposure (favor companies with fab diversification)
- Maintain US Treasury allocation (safe haven)
- Gold allocation: 10%+ for tail risk protection
- Avoid concentrated Asia-Pacific equity exposure
- Consider long-dated SPX put options as catastrophic hedge

Example 3: Election Volatility Trade

Setup: US presidential election in 4 weeks
- Polls: extremely tight race, within margin of error
- Market: VIX at 22 (elevated but not extreme)
- Options: November expiry vol elevated vs September (event premium)

Trade: Buy VIX call spread
- Buy VIX 25 call, Sell VIX 35 call (November expiry)
- Cost: $2.00
- Max profit: $8.00 (if VIX spikes to 35+)
- Risk/reward: 4:1

Complementary trade: S&P 500 iron condor (December expiry)
- After election, regardless of outcome, vol should crush
- Sell 5% OTM put and call spreads
- Profit from post-election vol decline
- Risk: contested result extends uncertainty (define stop)

Historical: VIX has declined an average of 4 points in the week
following election resolution, regardless of winner.

Quality Gate

Before trading geopolitical events, verify:

• [ ] Scenario analysis is written down with explicit probabilities — avoid anchoring on a single outcome
• [ ] Market pricing of risk is assessed — what is already priced in vs what is not?
• [ ] Trade is asymmetric — defined risk with outsized reward if underpriced scenario materializes
• [ ] Second-order effects are considered — sanctions -> supply chains -> inflation -> central bank response
• [ ] Safe haven correlation is understood — will your portfolio benefit or suffer from risk-off flows?
• [ ] Liquidity risk during event is planned for — spreads widen, slippage increases during geopolitical shocks
• [ ] Position sizing is conservative — geopolitical outcomes are inherently unpredictable
• [ ] Hedge cost is reasonable — not spending >2% annualized on geopolitical hedges
• [ ] Information sources are diversified — avoid relying on single narrative or news source
• [ ] Exit plan exists — define what would change your view and how you would close positions

Source & license

This open-source skill is cataloged on AgentStack and links to its original source — we do not rehost the code.

• Author: brainbytes-dev
• Source: brainbytes-dev/everything-claude-trading
• License: MIT

Install and usage instructions live in the source repository linked above.