That means you, Will.

Due to the intense boredom initiated by "a very special American Idol," I began channel flipping and became transfixed by the excellent PBS documentary called ENRON: The Smartest Guys In The Room.

[Aside: Let me note for the record that chief Enron assholes Lay, Skilling and Fastow were all baby boomers.]

Anyways they mentioned that Enron was a major promoter of the early "weather futures" market. When I heard that, I thought, weather futures? wtf? now I've seen everything.

But it's a real thing, and apparently weather futures have exploded on the Chicago Mercantile Exchange. In fact, volume on the CME jumped 64% in the last year alone. It's now a 45 billion dollar market.

But what is it? How do you trade weather? According to CME's website:

CME created a weather derivative market which enables those businesses that could be adversely affected by unanticipated temperature swing or unusually high snowfall, to transfer this risk. It is estimated that nearly 30 percent of the U.S. economy is directly affected by the weather. As a result, the earnings of businesses can be adversely impacted by summers that are hotter than normal or winters that are much colder than anticipated. Just as professionals regularly use futures and options to hedge their risk in interest rates, equities and foreign exchange, now there are tools available for the management of risk from extreme movements of temperature. This sector of hedging and risk management products represents today's fastest growing derivative market.

I guess the deal is that you can buy insurance to protect against catastrophic things that have a low probablility of occurring. But you can't easily insure against high probablility, low risk events like variations in the weather. Playing this market is a way for businesses to offset weather related losses. For example:

A ski resort depends on cold weather to stay in
business. To protect against the possibility of a warm winter, the resort can sell (go short) CME HDD contracts at a level they decide upon with assistance from a
weather-analysis company. A warm winter will result in a low HDD index, and the resort will hope to buy back its contracts at a lower price and use the profit to offset losses in the business.

Posted by: annika at 06:06 PM | Comments (6) | Add Comment
Post contains 422 words, total size 3 kb.