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Violence in Libya has reignited the fear trade on Wall Street. Investors always find a way to price risk...last year the Greek debt crisis found its way into the stock market through the rising dollar/dropping market trade...this year the market is pricing in risk of middle eastern turmoil through the rising oil/dropping market trade. Should we add an oil hedge to the portfolio? That question sounds like somebody back in 2008 asking, ‘Should we short a bank?’ Ummmm, let me think this through for a second, yes, it might be a good idea to short oil. The most intriguing statement I’ve heard came from analyst David Rosenberg warning about the potential hit should these Middle East and Northern Africa tensions spread to Saudi Arabia. He said that “pricing in Libya supply disruptions is one thing but what if this social unrest spreads to Saudi Arabia, which holds 20% of the world’s oil. If Libya can spark a $10 a barrel response and they control 2% of global oil, imagine what a similar uprising in Saudi Arabia could unleash. Do the math: we’d be talking about $200 oil.”

Is the fear of Saudi Arabian revolt warranted? Normally it would seem that Saudi Arabia's strong alliance with the US, its religious conservatism, and its popular rule under King Abdullah would isolate it from the turmoil of its neighbors but everyone knows these are not normal circumstances. The region is experiencing a pro-democracy movement like we have never seen and the facts show that King Abdullah is 87 years old and in bad health so of course there is a possibility of unrest. The NY Times reported that a phone conversation between King Abdullah and President Obama ended in sharp disagreement over the handling of Egypt and the revolt against Mubarak. If the US fails to support Saudi’s neighbor Bahrain, it could mark the first major shift in US-Saudi relations since 1945. As of today, investors should assume that anything is possible in Saudi Arabia because turmoil in Bahrain would be viewed as a tipping point. It has been reported that the Saudis would never allow the Bahrain monarchy to be overthrown, if it happens, watch out below. Any word of protest in Saudi will cause a significant oil spike.

With this as the backdrop, keep in mind our post from last week that showed the backtesting of what typically happens after the market rallies for 61 straight days without a 2.5% selloff. We are technically due for the Dow to drop to 11,700 and it appears the market has found the ammunition to make it happen.

We are adding an oil hedge that will begin with a 1% allocation of USO July 2011 $35 calls, a 1% allocation of UAL June 2011 $27 puts, a 2% allocation of SU and a 2% allocation of XOM. We are also adding a stagflation hedge that will rise should the higher food and oil inflation continue alongside slow economic growth. We are adding a 1% allocation of EEM June 2011 $47 puts. As is often the case with new positions, we will start with small allocations and feed the worthy positions.

As for the rest of the portfolio, the opportunity we are most excited about is obviously Apple (OTC:APPL). It's a wonderful thing to be expecting a selloff and then to actually get the selloff. It’s only been three days and the stock has dropped $25. Plain and simple, Apple dips in 2011 should be bought. I felt uneasy holding Apple at its 52 week high of $364 because it was in need of a ‘knee bend’ in order to jump higher. We are now getting that knee bend. Tuesday’s selloff began with what has turned out to be a bogus, hedge fund rumor suggesting the iPad 2 was facing production delays. The hedge funds got what they wanted with Apple down another $10. Wall Street was attracted to that headline because the market is in selloff mode but quietly it’s being reported this afternoon that Apple will be unveiling the iPad 2 next Wednesday on March 2nd. Remember the following excerpt from Friday’s economictiming.com update: ‘We anticipate Apple will hit $370 sometime prior to the iPad release in April, getting the chance to buy at $350 is good, getting the chance to buy at $345 would be even better, and getting the chance to buy below $340 would be a gift. Keep that in mind if Apple continues to drop over the next few trading days.’ This selloff is a major buying opportunity for Apple investors. Combining the Apple position with a strategic hedge of USO calls, UAL puts, EEM puts, XOM, and SU will allow you to safely manage risk.



Disclosure: I am long AAPL, USO, SU, XOM.

Additional disclosure: I also hold EEM puts and UAL puts

Source: 6 Investment Ideas for the Libyan Market Correction