Stock Market Could Be Held Hostage By Crude Oil Prices - FedEx (NYSE:FDX)

A major story that some financial media outlets appear to be overlooking is the disturbingly high degree of correlation between crude oil and risk sentiment. Do not be surprised, however, if this becomes front page news sometime in 2012. Simply put, any "risk on" rally in financial markets is being met with surging crude prices. Furthermore, crude oil has been much more volatile to the upside than the stock market in recent months. For example, over the last 90 days, the S&P 500 has risen 7.76%. The United States Oil Fund ETF

USO

, on the other hand, is up more than 20%. This would not be a big deal if crude oil was trading at $70 or even $80, but it is not. On Tuesday, the stock market is very moderately higher on the session, but NYMEX crude has jumped another 1.41% to above $101. Unfortunately, the strength in crude has been very persistent, even in the face of a rocky economic outlook. This could spell big trouble. If crude is trading at $101 with the S&P at 1,267 and with risk sentiment being shaky at best, what happens if the economy does turn around? Judging from the current dynamics, any bout of real optimism could send crude oil prices above $125 in short order. This in turn will provide a major drag on the economy once again, and any progress would thereby be quickly negated. It is a Catch-22. Unless something substantially changes in 2012 with regard to the dynamics playing out in the crude oil market, expect any good stock market and economic news to be quickly mitigated by soaring prices for crude oil. While crude and risk sentiment often show a high degree of positive correlation, a "tipping point" exists in this relationship. At some level, the risk markets, particularly stocks, will begin to react negatively to rises in oil prices. The reason for this is pretty obvious - soaring crude prices ripple through every layer of the global economy causing costs to rise across the board. If current trends persist, this theme could be a major storyline in 2012. Get realtime market updates and profitable trading ideas with Benzinga's news feed, Benzinga Pro,

here.

ACTION ITEMS:

Bullish:
Traders who believe that crude oil will continue to skyrocket, thereby hurting the stock market, might want to consider the following trades:

Buying out of the money call options on securities which benefit from rising crude prices. Consider buying calls on crude oil futures or an ETF such as the United States Oil Fund USO

In addition to buying out of the money call options on futures or the USO or another ETF, traders could short names such as FedEx FDX and UPS UPS which will face escalating costs amid a steep crude run up.

Bearish:
Traders who believe that crude prices will remain range-bound and are getting rich at current levels may consider alternative positions:

Buying puts on crude oil futures contracts of an ETF such as the USO.

Shorting oil sensitive names such as refiners. Examples would be Valero VLO and Tesoro TSO.

Buying transportation stocks that would benefit from falling crude prices.

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