Weather is an unpredictable beast: It directly determines the fate of ~30% of U.S. businesses, and it still sometimes wreaks havoc, albeit indirectly, on all other industries.
Extreme rainfall, drought, unusual temps, and monster winds have very real financial implications for companies in the agriculture, energy, construction, sports, travel and tourism industries.
It’s snow joking matter
Traditional insurance only covers low-probability, catastrophic events like earthquakes — not high-probability, less-dramatic-but-still-detrimental acts of nature like a crazy-warm winter.
But, in 1996, along came a financial umbrella in the form of weather derivatives — instruments that provide indexes for hedging risks and (whoa) turning weather into a tradable commodity with monetary value.
CME, a derivatives marketplace, allows companies to enter into insurance-like contracts, paying premiums to sellers to assume the risk of certain indexes related to temps, precip levels, etc.
Depending on whether the specified index threshold occurs within a given window (e.g., “If local temps fall below freezing at least 15 days in October”), either the seller keeps the profit or pays out — without requiring proof of damage.
Don’t rain on my trade
In 1999, CME introduced weather futures and options — exchange-traded derivatives. Unlike CME’s other, privately negotiated contracts, these futures are standardized and traded publicly on the open market via online auction and negotiation.
These derivatives are attractive portfolio additions to some investors due to their low correlation with traditional financial markets.
Since its introduction, the futures exchange has seen steady growth. CME currently lists derivative contracts for nearly 50 cities globally, and trading continues to increase.
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