Weather Risk Management: The Evolution of an Exchange-Traded Product

In 1999, CME introduced exchanged-traded futures and options on weather, geared to average temperature indexes in various locations. These products were the first of its kind. CME Weather futures are standardized contracts traded publicly on the open market, in an electronic auction-like environment, with continuous negotiation of prices and complete price transparency. Thus they are different from over-the-counter (OTC) weather derivatives, which are privately negotiated, individualized agreements made between two parties.

Initially, CME Weather futures focused on U.S. cities only.  The appeal of these useful financial tools quickly became apparent to international customers, who requested similar futures contracts to hedge their own weather risk.  In response, CME launched weather contracts in October 2003 on five European cities and on two Asia Pacific cities in July 2004. 

Also in 2003, CME expanded its weather product line-up beyond monthly weather contracts to include contracts based on a particular season.  Each season (summer or winter) represents five consecutive months that can be traded as one product. These seasonal products enable traders to hedge their weather exposure for the entire summer or winter.

In 2004, CME made two additional changes to its weather products in response to customer requests. It reduced the size of the contracts to $20 per contract from $100, and moved its options on weather futures to the CME trading floor from the CME® Globex® electronic markets.  This enabled CME to widen the product range and reduce the options strike intervals on the contracts.