What Are Weather Futures?

It’s now March but the winter isn’t showing signs of letting up. Over the weekend, a giant storm, Titan, dropped up to nine inches of snow in parts of the Midwest. Monday it affected the east coast.

The winter season that began in 2013 is set to be one of the worst on record. Often, we only look at its effects on us personally but a bad winter’s effects on the economy are often far worse.

Nearly 20 percent of the U.S. economy is directly affected by the weather. In 2010 a monster storm shut down Washington D.C. as well as much of the east and Midwest. It was estimated that each day that the Federal government was shut down, American taxpayers were out $100 million just in lost productivity from Federal government workers.

Add to that the airline industry, local business and others, and the effects can reach into the trillions.

But let’s look at it in terms of smaller subsets of the economy. What if you owned a ski resort? One year, the snow was plentiful; another year, such as the 2011 and 2012 season, snowfall was well below average. Because of that, you had to open your resort later than usual, severely impacting your revenue.

Related: Forget The Lions & Tigers...Bears Defending Their Turf

You had no control over the snowfall, but the employees and vendors you had to pay don’t much care that you can’t control the weather.

You can hedge a stock trade with put options to protect yourself, so why couldn’t a business do the same thing with weather futures? It can.

That ski resort can purchase snowfall futures to hedge against a lack of snowfall, just like orange growers can protect against crop-killing frost with frost futures.

Insurance is designed to cover catastrophic events like hurricanes or tornadoes. Futures contracts cover smaller events like an unusually warm winter, an unseasonably hot or wet summer, or other less extraordinary events.

Just like any openly traded futures contracts, anybody can trade weather futures. However, the large majority of the market comes from business owners who are hedging. As a tradable market, it’s often too speculative because of the unpredictability of the weather. As a hedge, the unpredictability is what makes the product attractive to those looking to mitigate risk.