Investors who are concerned about a default should use an options strategy known as a collar on their largest or most volatile equity holdings, according to Randy Frederick, managing director of active trading and derivatives at Charles Schwab Corp. in Austin, Texas. To implement the trade, investors buy a put, or option to sell, with an exercise price below the current stock level, financed by selling call options with a higher strike price.

VIX Options

Randall Warren, chief investment officer of Warren Financial Service, purchased options on the VIX as protection against surging stock volatility if the U.S. defaults on its debt.

Warren said he bought calls that become profitable if the VIX rises 12 percent to 22 by Oct. 16, the day before U.S. borrowing authority lapses. He also purchased calls with a 32 strike price for October to protect against bigger swings in the equity market, as well as 22 and 32 contracts that expire in November as a hedge if the talks are extended.

“Buying these options very, very cheaply and getting the explosive upside if something serious does occur with the markets, then that is a way to hedge your bets without a whole lot of money,” Warren, who oversees about $100 million, said in a phone interview from Exton, Pennsylvania.

‘Worst Case’

The S&P 500 has fallen 1.5 percent since the U.S. government shut down last week, and the VIX has jumped 18 percent to 19.6. That compares to a level of 48 when S&P cut the U.S. debt rating in August 2011, the highest since before the bull market started in 2009.

Supreeth S.M., the Bangalore-based chief executive officer at Quant First Asset Advisors India, bought put options on the nation’s CNX Nifty Index stock gauge with an exercise price 10 percent below the index level to protect against the “worst case scenario” of a U.S. default. He’s funding the trade by selling call options on the measure.

“A U.S. default is highly unlikely as we expect lawmakers to come around to avert a disaster,” Supreeth, whose firm manages about $100 million in options, said in a phone interview on Oct. 8. “However, something bad may happen and we are advising clients to hedge.”

Treasury Hedges