An Overview Of Weather Binary Options

Best Binary Options Brokers 2020:
  • Binarium
    Binarium

    Best Choice!
    Free Trading Education!
    Free Demo Account!
    Big Sign-Up Bonus!

  • Binomo
    Binomo

    Good Choice For Experienced Traders!!!

Weather Binary Options

Now we’re betting on the weather? Yes and what a lucrative and exciting market it is too. While we often make comments about the state of the weather and how it affects us, we may never stop to think if we can speculate on the weather. Now that has changed with the introduction of weather binary options by the Chicago Mercantile Exchange (CME).With the introduction of the Carvil Hurricane Index (CHI™ ) range of futures and options, retail financial traders now are able to speculate on the state of the weather for a financial return. Just like traditional binary options, weather binary options let the option holder earn a fixed payout if the option closes in the money. And just like traditional binaries, weather binary options are also offered as “Call” and “Put” options.

Foundation of Weather Binaries
While traditional binaries base their prices on the prices of underlying assets, the prices of weather binaries are based upon weather data collected from weather stations around the country such as the National Weather Service. For the CME range of weather binaries, their prices are based upon the CHI™. Developed from the work published by Lakshmi Kantha, the CHI™ seeks to measure the potential of damage that can be inflicted by an Atlantic hurricane. Using the maximum speed and radius of the hurricane, these storms in designated areas are tracked from their birth to their end. Apart from storms, some weather binaries also seek to track the temperature of major cities around the country.

Why Trade Weather Binaries?
Although weather binaries are only a recent creation, they do have their relevancy in today’s modern financial world. They came about as result of the need for such an instrument to help the losses that would have resulted from a devastating storm such as Hurricane Katrina or Hurricane Sandy. In other words, it provides those with hurricane exposure a simple method of hedging against potential losses.

Another reason for trading weather binaries is simply profits. It is just another avenue for which interested parties can use their intuition regarding the weather to profit with their skill.

An Overview Of Weather Binary Options | BinaryOptions.net

Now we’re betting on the weather? Yes and what a lucrative and exciting market it is too.

Weather Options Overview

CME Group received approval from the Commodity Futures Trading Commission (CFTC) to list Heating and Cooling Degree Day (HDD and CDD) futures in August 1999. The very first weather futures contracts listed in September 1999 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 2000.

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. HDD & CDD represent energy industry standard measures of the extent to which average temperatures during a particular day deviate from a (benchmark) of 65 degrees Fahrenheit.

The concept of a heating degree day (HDD) index was developed by engineers who observed that commercial buildings were frequently heated to maintain an indoor temperature of 70° Fahrenheit whenever daily mean (average) outdoor temperatures fell below 65° Fahrenheit. Each degree of mean temperature below 65° Fahrenheit is counted as “one heating degree day.”

Conversely, air conditioning may be employed when temperature rise much above the 65° Fahrenheit standard. Thus, each degree of mean temperature above 65° Fahrenheit is counted as “one cooling degree day.” These concepts are expressed mathematically as follows.

HDD = Max(0, 65°F – daily average temperature)

CDD = Max(0, daily average temperature – 65°F)

Best Binary Options Brokers 2020:
  • Binarium
    Binarium

    Best Choice!
    Free Trading Education!
    Free Demo Account!
    Big Sign-Up Bonus!

  • Binomo
    Binomo

    Good Choice For Experienced Traders!!!

For example, if the average of a day’s maximum and minimum temperature on a midnight-to-midnight basis is 35° F, that day’s HDD is 30 and the CDD is zero (0).

The original HDD and CDD futures are based on the cumulative value of HDDs or CDDs throughout a specific subject month. To illustrate, an average daily temperature of 45°F degrees is associated with an HDD of 20 (= 65°F – 45°F). If the average daily temperature were in excess of 65°F, the HDD for that day would be zero. A monthly contract is cash settled at the cumulative value of HDDs recorded on each day of the month.

For example, assume that the month had 31 days and the average daily temperature for all of those days was 45°F. Accordingly, the cumulative monthly HDD would equal 620 (= 31 days x 20). The futures contract value would be identified by multiplying that figure by $20. In this example, the cash value of the contract would be $12,400 (= $20 x 620).

A seasonal strip contract is based on the cumulative HDD or CDD values during a five-month period within the season. 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 HDD 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.S. standards in the sense that temperature readings are recorded on the Celsius rather than Fahrenheit scale. Rather than reference a base of 65°F, these indexes reference a base of 18°C. The European cooling contracts are based upon a so-called Cumulative Average Temperature (CAT) index rather than a CDD to the extent that the term CDD is not in use in the context of European OTC weather markets.

Weather products offered by CME consist 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.

Let’s examine how a utility would use a CDD option strategy to account for a forecasted mild summer in the Northeast and how the strategy would change as the forecast changes. (The pricing of all option strategies is based strictly on historical averages and may not accurately reflect the cost of the hedge).

1. The utility receives its summer forecast and elects to BUY a 1250 CDD Put option (capped with a 1050 PUT) @ 30 ticks per contract to protect $5,780,000 in revenue.

  • Timeframe: May – September (5-month “summer” seasonal strip)
  • Seasonal 10-year average for New York: 1352
  • Strike prices: 1250 (cap is 1050)
  • Option premium: $600 per contract
  • Cost of “The Hedge”: $1,020,000 (max potential loss)
  • Max potential payout: $6,800,000
  • $5,780,000/170 = 34K per CDD
  • 34K per CDD/$20 = 1,700 contracts
  • 30 ticks*$20/tick*1,700 contracts = $1,020,000

“The Hedge”: The utility would pay a premium of $1,020,000 for $5,780,000 in protection.

2. The utility received an updated forecast from their meteorological source that projects a warmer than average for the start to summer. The risk manager negotiates to SELL 500 of the 60 PUT option (no cap) @ 10 ticks/contract.

  • The forecast for May: 90
  • New York 10-year avg. for May: 71
  • Strike price: 60
  • Option premium: $200 per contract
  • Max potential payout: $100,000
  • Max potential loss: $600,000 (max net loss: $500,000)
  • 10 ticks*$20/tick*500 contracts = $100,000

“The Hedge”: The utility would receive a premium of $100,000

3. The utility received a forecast from their meteorological source that projects a cooler outlook for June. The risk manager negotiates to SELL 500 of the 270 CALL option (capped with a 370 CALL) @ 17 ticks/contract.

  • The forecast for June: 225 Location: New York (10-year avg. for June: 259)
  • Strike price: 270 (capped at 370)
  • Option premium: $340 per contract
  • Max potential payout: $170,000
  • Max potential loss: $1,000,000 (max net loss: $830,000)
  • 17 ticks*$20/tick*500 contracts = $170,000

“The Hedge”: The utility would receive a premium of $170,000

4. The utility receives an updated forecast that projects a warmer outlook for July. The utility elects to SELL 500 of the 430 PUT option (capped at 380 PUT) @ 15 ticks/contract.

  • The Forecast for July: 487
  • Location: New York (10-year avg. for July: 444)
  • Strike price: 430 (capped at 380)
  • Option premium: $300 per contract
  • Max potential payout: $150,000
  • Max potential loss: $500,000 (max net loss: $350,000)
  • 15 ticks*$20/tick*500 contracts = $150,000

“The Hedge”: The utility would receive a premium of $150,000

There are many strategies and instances where both futures and options can be utilized for hedging various temperature related risks. CME Group offers both futures and options products in 10 cities to help better serve our customers and the market places’ needs.

Best Binary Options Brokers 2020:
  • Binarium
    Binarium

    Best Choice!
    Free Trading Education!
    Free Demo Account!
    Big Sign-Up Bonus!

  • Binomo
    Binomo

    Good Choice For Experienced Traders!!!

Like this post? Please share to your friends:
Binary Options Trading Guide
Leave a Reply

;-) :| :x :twisted: :smile: :shock: :sad: :roll: :razz: :oops: :o :mrgreen: :lol: :idea: :grin: :evil: :cry: :cool: :arrow: :???: :?: :!: