Weather derivatives
Weather derivatives are financial instruments that can be used by farmers to hedge against adverse weather conditions, such as drought or frost. The difference to other derivatives is that the underlying asset (rain/temperature/snow) has no direct value to price the weather derivative.
Weather derivatives can be used by people and institutions other than farmers.
For example, power companies may use HDD (Heating Degree Days)* contracts to smooth earnings.
Theme parks may want to insure against rainy weekends during peak summer seasons.
There are other, more specific examples listed on the web, but I'm not sure if I can repeat the details here.
From personal experience, farmers are not the most common users of these instruments.
- Heating Degree Days are one of the most common types of weather derivative. e.g., for the November- March period, for each day where the temperature falls below (65 F?) (18 C) keep a cumulative count. Depending upon whether the option is a PUT or a CALL, pay out a set amount per heating degree day that the actual count differs from the strike.
