Trading Weather and Making it Rain

If you could trade weather and make money, would you do it? Or better yet, even think that it is possible? You could add this as something being bizarre and Ripley may add it to his bizarre collection. Believe it or not, it is possible to trade weather. More specifically, weather is traded as a derivative. Trading weather was first introduced in the 1990’s and became pretty active in trading which is now on the Chicago Mercantile Exchange.

However, how would one be able to trade weather as a derivative? More importantly, how would you even be able to create the foundation or structure on how to trade weather? Interestingly enough, trading weather is a lot easier than what it might seem. They are traded base of the averages of the month or season within a city or region. They are also scaled by a dollar weighted index.

This is how it works:

Contracts are linked to index for heating degree days (HDD) and cooling degree days (CDD) based on set temperature threshold of 65° F in US (18° C in Europe). These values indicate quantum of available resources needed for heating or cooling.

If temperature goes below this threshold to say 35° F indicating heating requirement, then HDD value is 30 (65-35) and CDD value is zero as no cooling is required. For temperature above this 65° F threshold, say at 85° F, HDD will be zero as no heating is required, while CDD value will be 20 (85-65).

Now, here is how it is valued:

Each contract is valued for each day (or month) by multiplying the HDD or CDD value by $20. For the first case (HDD = 30 and CDD = 0), HDD contract value will be $600 and CDD will be zero. For second case (HDD = 0 and CDD = 20), HDD contract value will be zero and CDD contract will be $400.

I stumbled upon this article on Investopedia.com while reading about investing. I never knew that weather was a traded derivative, more specifically through contracts. While I was intrigued, I also thought who would trade weather? While reading further into the article, I realized that this aligns with businesses, farmers, some event management companies, energy companies, and governments. I think this is interesting but I do not think that this would be for the individual investor besides a farmer. Interesting as it is, I don’t think that it would be useful from an individual standpoint. Maybe this is where the phrase "making it rain" originally came from, but that is pure speculation.

Fellow monkeys, were any of you aware that weather could be traded? Furthermore, what are your thoughts about this? Do you think that trading weather would be beneficial to investors besides the larger institutions and organizations that would be affected by weather conditions? What do you think about how it is structured as a trade and the value? Interesting to say the least?

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IRconsult:

yeah, you can create strategies, especially with electricity or home heating oil as directional trades or hedges

That's what I was thinking. Some directional ETFs like UGAZ shift significantly with unexpected weather conditions.
"Decide what to be and go be it." - The Avett Brothers
 

They will just end up hedging for you(if your a business) on the CME and collect a commission for their services. This is not any different from what is done for the Agricultural market. Any futures brokerage can trade weather.

Please don't make me talk to you like an asshole...
 

@ Bravo: Why do you think they go via CME? The CME does only offer very few weather stations. This CelsiusPro company offers like tons and tons of weather stations in many countries.

I did a bit more research and they work with Swiss Re for risk transfer rather than hedging on the CME. They actually structure all derivatives themselves.

 

Nice thing about this company is that it seems they offer the derivs for just about any budget. The commoditiy shops you talk about probs don't serve the mid and small cap companies. Plus they do not have the same expertise I would assume.

Anyways, my test certificate has started and I am looking forward to the outcome.

Have you opened an account?

 

Yeah, I think they also tried to set up a weather derivatives exchange in Nairobi, Kenya, as this country is particularly vulnerable in weather changes. There are also other financial derivatives contracts such as Forward Freight Agreements for tankers/shipping (exchanges in Oslo, London and NY) and there were efforts made on real estate prices derivatives, too, though with limited success as far as I'm aware.

Colourful TV, colourless Life.
 

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