Weather: some investors like it hot
Temperatures soaring to record highs, people sweating, air con running at full capacity in offices, summer has kicked off in the Northern Hemisphere.
Weather is a tradable commodity like another according to CME Group that trades US and Europe weather heating and cooling futures on derivative exchange CME.
“CME Weather futures and options are all index-based products. Indexing makes it possible to trade weather in a way comparable to trading other index products such as stock indexes. Weather futures quantify weather in terms of how much the temperature deviates from the monthly or seasonal average in a particular city or region,” tells CME Group to InvestmentEurope.
The variations are geared to specific indexes, with a dollar amount attached to each index point, the firm says.
“For example, summer weather is measured in terms of average temperatures that exceed a base of 65 degrees Fahrenheit (18 degrees Celsius in Europe) and referenced to a Cooling Degree Day (CDD) Index. Winter weather is measured in terms of how much average temperatures are below 65 degrees and referenced to a Heating Degree Day (HDD) Index.”
Two temperature-based indexes remain at the core of its European monthly or seasonally futures.
The first is the Heating Degree Day for which the baseline of 65 degrees Fahrenheit (18 degrees Celsius) is far from randomly chosen, as it has been selected by utility companies since furnaces and air conditioners are turned on above and below this benchmark. Positive payoff can be therefore expected when cumulative average temperature is above or below 65 degrees Fahrenheit depending of the contract.
The other index is the CME Cumulative Average Temperature (CAT) Index, corresponding to the accumulation of daily average temperatures over a calendar month, with the accumulation period starting from the first calendar day of the contract month and ending with the last day of the contract calendar month.
CAT contracts are available for summer months in Europe and track average daily temperature in a given city – like Amsterdam and London.
CME Group points out that a wide range of players are investing in weather futures that include, among others, insurance and reinsurance companies, utility companies, energy companies, retailers, hedge funds, pension funds, and state governments.
Asked if global warming and climate change trends are to open opportunities for the launch of new weather futures, CME says it does not speculate about product offering but continually talk with its clients about new products to help them manage risk.
How hot does CME Group expect this summer to be in Europe? “As the neutral exchange where price discovery and risk transfer takes place, we are not able to provide weather or market predictions or outlook,” the firm answers.