Weather Futures and Options

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Thank you for stopping by the Weather Watch 12 blog! The topic in this blog is one we have never discussed before, and one that will likely generate a good deal of discussion.

Recently I learned about Weather Futures and Options that are available at the Chicago Mercantile Exchange. The weather trading is available for snowfall, rainfall, and temperatures. In other words, you can now invest, or as some may view it, gamble on the weather.

Roulette Wheel

On February 22 I traveled to the Chicago Mercantile Exchange, or CME Group, to meet with Jeff Hodgson. Jeff is the President of the Chicago Weather Brokerage, part of CME Group. Here is a picture of Jeff.

Jeff Hodgson - Chicago Weather Exchange

I interviewed Jeff for just over 20 minutes on what weather futures and options are all about, who may be interested, and is it essentially gambling on the weather?

Let’s start with how the CME Group describes this market:

One-third of businesses worldwide are directly affected by weather conditions. These products enable you to manage weather-related risk while also offering opportunities to speculate β€” absorbing that risk in exchange for possible profit on weather variations. Our weather product suite offers trading opportunities related to temperatures, snowfall, frost and hurricanes. The products are based on a range of weather conditions in more than 47 cities in the United States, Europe, Canada, Australia and Asia, with the hurricane products geared to nine U.S. regions.

The website for the weather products offered from CME Group is below.

http://www.cmegroup.com/trading/weather/

My conversation with Jeff was fascinating because it has been a goal of mine to figure out how this market works. While anyone can participate, it is geared toward businesses that are weather dependant. Here are some of the questions that I asked Jeff during my visit, and his response.

What is a future or option and how is a trade executed at a very basic level?

“It is a trade, you could be a client who has a natural exposure to the weather. I would go out and get the financial participants to compete for your business in essence. Once we have a fair price or the best price possible, and you believe its a fair price, we match those trades up and then they are reported to the Exchange.”

Can farmers or those in the agricultural industry benefit from these trades, if so how?

“What the rainfall derivatives enable a farmer to do, in place of crop insurance or on top of crop insurance, is it gives you a tool to manage your own risk.”

“So insurance you don’t have anything until the end, this actually has a day to day value that is in my opinion something that could completely change the agriculture market.”

Besides snow removal and salt companies, who could benefit as the seasons change with rainfall contracts?

“You have the agriculture market. I think you have the pest control industry, you have large golf course exposure in the Milwaukee area.”

So does Jeff feel that this is gambling on the weather?

“If your business is dependent upon the weather you are actually gambling by not participating in this marketplace, because your revenue is driven off of something you cannot control. So by you not participating and by not hedging this, you are actually the gambler.”

Here in southeast Wisconsin I talked about trading on the weather with Fritz Frazier, owner of Winter Services, a local snow removal company. Snow, too much or too little can make or break his business. While Fritz said he has not bought a snowfall future or option yet, he is considering it for the future, here’s why.

“Buying salt, buying new equipment, buying trucks, and your getting that all over the state of Wisconsin trying to get ready. And if it doesn’t snow that’s a big issue”

“So as a small business it’s really nice to be able to have weather futures like that.”

Here is a picture of Fritz(first person in line) and his team.

Winter Services Team

Weather trading is relatively new to the CME Group, it is growing rapidly as 2-3 trillion dollars of economic output if affected by weather! While it is investing and hedging a potential weather risk, it is an investment and that means you could make or lose money!

What do you think about weather futures and options? Let us know in the comments section of the blog!

Have a great day!

Jeremy Nelson

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10 Responses

  1. Very interesting article and story on TV.

    One thing, and I don’t believe anyone else has noticed or asked about this but, Jeremy, how tall are you????

    πŸ™‚

    Michael

    • Michael…6’5 with shoes on.

      • I’m just glad he’s wearing shoes in the office. πŸ™‚

  2. I can’t help but be skeptical of this. Derivatives helped wildly inflate the housing market and we all know what happened there. This just seems like another finacial tool that will make people like Jeff very weathly and likey leave business owners and municipalities holding the bag.

    • Dave,

      Certainly any investment carries a risk with it. I think if people invest wisely, based on their risk and needs then this is something that could be beneficial.

      Jeremy

  3. Jeremy, nice story. If I understand this correctly, an individual like myself could make some good coin by betting against the LRC as the only way to win in this gamble is for the weather to do the opposite of what is desired. ???

    • Josh,

      You would be investing in what you think is going to happen if you are speculating. If you are a company trying to hedge a risk, you are putting money on say very little snow. This is protecting your snow removal business in the case of a ‘light’ winter.

      Jeremy

    • πŸ˜‰

  4. What a wonderful idea!! What could possibly go wrong?

  5. Hah wow interesting stuff!

    Jeremy and Mark, WOW this storm on Saturday looks to be a whopper! What, 1.25″ precip showing up on several different models? I’m sure things will change as always, but this looks to be an interesting one. Can’t wait to hear your input in the coming days. Have a great night πŸ˜€

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