Options weather, Market Futures: Introduction to Weather Derivatives
The very first weather futures contracts options weather in September were based upon HDDs to the extent that this coinciding with the commencement of the heating season.
CDD based contracts were subsequently introduced in January At the outset, the two most popular instruments to emerge included option contracts based on heating degree days HDD and cooling degree days CDD options. A monthly contract is cash settled at the cumulative value of HDDs recorded on each day of the month.
The traditional heating season runs from November through March while the traditional cooling season runs from May through September. Seasonal strip contracts provide the same type of risk exposure as monthly Options weather and CDD contracts but offer the convenience of being able to trade a bundled package of months during the heating or cooling season.
The concept of temperature linked futures also includes international coverage in Europe Amsterdam and London. These contracts are based upon cumulative average monthly temperatures during the cooling season and HDD readings during the heating season.
These contracts further depart from the U. Weather products offered by CME options weather of both futures and options.
In the following section of this paper we would like to describe a few examples of how options on weather futures can be utilized as a hedging mechanism in the energy sector.
The pricing of all option strategies is based strictly on historical averages and may not accurately reflect the cost of the hedge.