The premise of a weather-based strategy is that, if the weather variables predict daily returns, we can use the predicted returns to form a profitable trading strategy.
Table of contents
- Popular News
- Commodity Spread Trading Strategies
- Tailor-made trading strategies, increasing returns
- Bespoke Weather Services Research | Interactive Brokers Luxembourg SARL
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Popular News
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Commodity Spread Trading Strategies
It is highly unlikely that the past will repeat itself. Selecting an advisor, fund, or strategy based solely on past returns is a poor investment strategy. In an Opalesque video interview, Nephila Capital 's Barney Schauble described how some hedge funds treat weather derivatives as an investment class. Counterparties such as utilities, farming conglomerates, individual companies and insurance companies are essentially looking to hedge their exposure through weather derivatives, and funds have become a sophisticated partner in providing this protection.
There has also been a shift over the last few years from primarily fund of funds investment in weather risk, to more direct investment for investors looking for non-correlated items for their portfolio. Weather derivatives provide a pure non-correlated alternative to traditional financial markets. An online weather derivative exchange Massive Rainfall [2] was created in and has been used to bet or hedge on specific temperatures, wind speeds and rainfall for specific days in select cities, however it appears to be only an educational tool for practice accounts in a non-existent currency.
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There is no standard model for valuing weather derivatives similar to the Black—Scholes formula for pricing European style equity option and similar derivatives. That is because the underlying asset of the weather derivative is non-tradeable which violates a number of key assumptions of the BS Model. Typically weather derivatives are priced in a number of ways:. Business pricing requires the company utilizing weather derivative instruments to understand how its financial performance is affected by adverse weather conditions across a variety of outcomes i.
Alternatively, an investor seeking a certain level of return for a certain level of risk can determine what price he is willing to pay for bearing particular outcome risk related to a particular weather instrument.
The historical payout of the derivative is computed to find the expectation. The method is very quick and simple, but does not produce reliable estimates and could be used only as a rough guideline. It does not incorporate variety of statistical and physical features characteristic of the weather system.
Tailor-made trading strategies, increasing returns
This approach requires building a model of the underlying index, i. The simplest way to model the index is just to model the distribution of historical index outcomes. We can adopt parametric or non-parametric distributions. For monthly cooling and heating degree days, assuming a normal distribution is usually warranted. The predictive power of such a model is rather limited.
Bespoke Weather Services Research | Interactive Brokers Luxembourg SARL
A better result can be obtained by modelling the index generating process on a finer scale. In the case of temperature contracts, a model of the daily average or min and max temperature time series can be built. Catering to traders, speculators, hedgers and those looking for weather protection, TradeWeather provides tools and information to help you create and manage a weather portfolio.
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