A weather future is a type of investment that allows companies and individuals to invest in weather conditions on specific days. This type of investment is generally designed to help businesses hedge themselves against the risks associated with the weather. Many businesses stand to lose a substantial amount of money when the weather acts differently than normal and the weather future gives them a way to be protected. Weather futures can be set up between two parties or they can trade on the open market just like a stock. It is also important to realize that weather futures are different than weather insurance.
The weather future is an investment that was first developed in 1997. This was done in response to growing concerns by large industries about the potential financial disasters that could occur as a result of weather. The weather future is essentially a way to standardize weather conditions and trade them just like a stock index or some other similar type of investment.
In order to standardize the weather, the system uses the amount of variation from 65° Fahrenheit. The variance from this value is measured in HDD or CDD. HDD stands for heating degree day while CDD stands for cooling degree day. This is basically a way to determine whether individuals are more likely to use heat or air conditioning in their homes.
The majority of weather futures trade on an exchange just like stocks or exchange-traded funds. This allows investors to buy or sell weather futures from anywhere in the world. In some cases, a weather future contract can also be made between two individual companies.
The primary reason that weather futures are used is to help businesses hedge risks. Many businesses, such as energy companies, stand to lose large amounts of money if the weather does not behave as normal. For example, if the weather is unusually cold in the summer, a large theme park could lose large amounts of money. By investing in weather futures, the company can mitigate this risk and be compensated if the weather does not cooperate.
Some people get weather futures and weather insurance confused. Even though they are similar, they are two completely different products. Weather futures are used to combat against the risk from long-term situations such as a colder average temperature over the course of a month. Weather insurance is used to protect businesses against unexpected events such as a hurricane or a flood.