Geopolitical Risk Premium in Oil: How Iran Protests Are Reshaping Hedging Strategies and Price Volatility

The geopolitical risk premium in oil markets has emerged as a critical factor in 2025, driven by escalating tensions in Iran and their cascading effects on global energy dynamics. As protests in Iran-the largest since 2022-threaten to disrupt its 2 million barrels per day (b/d) of oil exports, traders and investors are recalibrating hedging strategies to navigate heightened volatility. This shift is reshaping not only price trajectories but also the mechanics of options positioning and risk management frameworks in energy markets.

The Mechanics of Geopolitical Risk Premiums

Geopolitical risk premiums function as an implicit insurance cost against supply disruptions. In late 2025, these premiums expanded rapidly as Iran's unrest intensified. For instance, West Texas Intermediate (WTI) crude prices surged toward $60 per barrel, while Brent crude exceeded $63, reflecting market incorporation of uncertainty around potential closures of the Strait of Hormuz-a critical chokepoint for 20% of global oil flows according to EnergyConnects. According to Bloomberg, commodity trading advisers held 91% short positions in WTI crude as of January 2026, creating a fragile equilibrium where even minor geopolitical escalations could trigger explosive price swings through short-covering dynamics.

This positioning underscores a paradox: while bearish fundamentals (e.g., global supply surpluses) persist, the psychological impact of geopolitical risks amplifies price volatility. When tensions flare, forced short-covering by institutional traders-driven by the need to rebalance portfolios-can propel prices beyond fundamental supply-demand balances. For example, during U.S.-Iran diplomatic escalations in late 2025, WTI prices surged even after regular trading hours, illustrating how risk premiums operate independently of traditional market forces as DiscoveryAlert reports.

Strategic Options Positioning and Hedging Innovations

Options markets have become a barometer for gauging the market's appetite for risk. As geopolitical uncertainty peaks, traders demand higher premiums for protection against extreme price swings. In late 2025, the call skew for Brent crude futures-the difference between call and put premiums-reached its steepest level since July 2024, reflecting heightened demand for upside protection according to Bloomberg. This trend aligns with broader shifts in hedging strategies, where investors are increasingly deploying complex instruments like straddles and collars to mitigate exposure.

For instance, during the June 2025 Israel-Iran conflict, oil traders utilized volatility surfaces-three-dimensional representations of implied volatility across strike prices and maturities-to price in a range of scenarios. These surfaces incorporated probability-weighted assessments of supply disruptions, including a 70% likelihood of diplomatic resolution, a 25% chance of limited military engagement, and a 5% risk of Strait of Hormuz closure as reported by Bloomberg. Such frameworks enabled investors to hedge against both moderate and extreme outcomes, albeit at elevated cost.

The Role of Institutional Behavior and Market Psychology

Institutional positioning further amplifies the impact of geopolitical risks. Hedge funds, for example, turned more bullish on crude oil in late 2025, increasing long positions in U.S. crude futures amid concerns over Iran's potential to disrupt exports according to Energy News. This shift was partly driven by the resumption of Venezuelan oil exports, which provided a temporary buffer against price spikes. However, analysts caution that the market remains underestimating the risks of prolonged instability in Iran, particularly as work stoppages in its oil sector threaten to disrupt 1.9 million b/d of exports as Investing.com reports.

The psychology of trader behavior also plays a pivotal role. Extreme bearish positioning-such as the 91% short positions in WTI-creates conditions where even modest geopolitical events can trigger self-reinforcing price rallies. As noted by Reuters, these short-covering dynamics can add $5–15 per barrel to crude prices within trading sessions, prolonging volatility for weeks according to Reuters. This mechanical response underscores the importance of incorporating behavioral economics into risk management frameworks.

Broader Implications for Energy Markets

The interplay between geopolitical risks and hedging strategies has broader implications for global energy markets. First, the Strait of Hormuz remains a focal point of concern. While a closure is low probability, its potential impact-estimated to add $40 per barrel to prices in extreme scenarios-continues to influence investor sentiment according to Facet. Second, the resilience of oil prices to geopolitical shocks-evidenced by their return to pre-conflict levels after the June 2025 Israel-Iran war-suggests that markets are adapting to an era of energy abundance. However, this adaptation is contingent on the availability of real-time data (e.g., satellite surveillance) and diversified supply sources, such as U.S. shale production as CSIS analysis indicates.

Conclusion: Navigating the New Normal

For investors, the 2025 Iran crisis highlights the need for sophisticated risk management tools. Hedging strategies must account for both the probability of supply disruptions and the psychological amplification of price swings. Options positioning, volatility surfaces, and diversified portfolios (e.g., natural gas, energy equities) are essential for mitigating exposure. Meanwhile, policymakers and market participants must remain vigilant about the cascading effects of geopolitical risks on inflation and global supply chains.

As the energy landscape evolves, the geopolitical risk premium will remain a defining feature of oil markets. Its management will require not only technical expertise but also a nuanced understanding of the interplay between politics, psychology, and market fundamentals.