Weather derivatives traders cash in on heatwave

by Artemis on July 22, 2011

The U.S. has been suffering from unusually high temperatures, dry weather and heatwaves across many regions in recent days and weeks. High temperatures mean weather traders are busy as companies and traders seek to hedge their weather risks using instruments such as weather derivatives.

Savvy weather traders are apparently cashing in on the high temperatures as prices for certain degree-day weather derivative contracts on the Chicago Mercantile Exchange (CME) have soared.

Those who bet that the temperature would rise have seen the value of their contracts increase dramatically. This article on the Toronto Globe & Mail news website says that some contracts on the CME have jumped by as much as 60% in the past month.

They say that the Chicago cooling degree day future, derived from temperature changes above/below the 65°F point is now trading 50% above its 10 year average. When temperatures are above 65° the value of the contract rises. On the 3rd June the contract was traded at 268 cooling degree days, it’s risen considerably since then and hit 450 on Thursday. Each cooling degree day point is worth $20 meaning the contract now trades up by $3,640.

So some weather traders will make significant amounts of money from the heatwave, but of course others will lose. As with all weather derivative markets there are businesses and traders who stand to benefit from the heat and those who stand to lose. Hence the need for weather trading which allows businesses to hedge the risks of hotter and/or colder than normal temperatures (among other weather features such as precipitation).

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