LONDON Abydos Capital, a new hedge fund run by a former partner at one of London's most high-profile oil investors, is worried about a potential military strike against Iran and plans to use options to protect his portfolio.
Jean-Louis Le Mee, Chief Investment Officer of Abydos, told Reuters he thinks there is a 25 to 50 percent chance of an Israeli strike against Iran's nuclear capabilities, an act that would likely send stock markets tumbling and drive up oil prices, hitting hedge funds that hadn't protected their portfolios.
Le Mee, who said he had based his views on discussions with Middle Eastern investors, said there was a "big discrepancy" between what the oil and stock markets were pricing in about the likelihood of an attack, with stock markets giving less weight to any potential attack.
Le Mee, one of the first hedge fund managers to discuss such a strategy, said he was planning to use options to profit from a spike in oil prices and a fall in equities via the S&P 500 index .SPX if Iran was attacked over its nuclear programme.
"There's a high chance that something will happen either this summer in June/July or after the U.S. elections," said Le Mee, whose former firm BlueGold made headlines in 2008 by calling the peak of the market. "If talks break down, then the Israelis could do something very quickly.
"If Iranian production goes to zero ... it would not be crazy to see Brent prices of $170, $180, $190 (per barrel)," Le Mee, who is putting $8-$10 million of his own money into Abydos, told Reuters in an interview. The fund has raised $25 million of initial capital.
A typical hedging policy could see a fund buy call options, the right to buy at a certain price, on an asset it expects to rise, and buy put options, the right to sell at a predetermined price, on assets it expects to fall.
Brent crude futures were trading around $120 a barrel on Friday afternoon.
"If something terrible happens, you'd make 6, 7, 8 percent for the portfolio. If we launched the portfolio tomorrow we would definitely have it (the trade) on," Le Mee said.
Israeli Defence Minister Ehud Barak restated Israel's fears of a nuclear-armed Iran on Thursday after his top general had clashed with the government's line by describing the Islamic republic as "very rational" and unlikely to build a bomb.
Le Mee is also cautious about economic conditions and believes markets are too relaxed about slower growth in China and the potential for more shocks from the European debt crisis.
"I'm very cautious. I expect more downside," he said, adding he would not be surprised to see a 7-8 percent fall in the S&P index. "The situation in Europe is very worrying."
In general, the fund would plan to spend a small proportion of fund assets on option premiums every year, which would pay for themselves if the market saw at least two violent corrections in that time span.
Protection using options will be key to the success of the fund, so a market slide does not force it to liquidate small to mid-cap shares and miss out on developments expected to boost their value.
Le Mee, whose new firm is based opposite the historic Royal Academy of Arts in London's hedge fund district and which hopes to launch its fund on July 1, was a founding partner at oil-focused hedge fund BlueGold Capital, which he left in June last year.
BlueGold told investors earlier this month it was liquidating after four years of trading, three of which saw fat returns, but the last put it at the bottom of commodity hedge fund rankings.
Le Mee was in charge of commodities stocks at BlueGold and plans to use that expertise in Abydos, which will have capacity of $500 million and will return cash to investors if assets rise above that level.
Abydos is the name of an Australian iron ore project owned by Atlas Iron (AGO.AX), which proved a lucrative investment for Le Mee at BlueGold.
The new fund plans to have an equal split between energy shares and minerals stocks, including gold, silver, copper, iron ore, potash and uranium.
About half will be resource majors and the other half small and mid-cap stocks that have strong catalysts for growth and market values of $500 million to $1.5 billion.
(Editing by Will Waterman)