Betting on Hurricanes Gains Traction

The National Oceanic and Atmospheric Administration (NOAA) forecasts a “near normal” hurricane season, and so far there have not been any named storms in the Atlantic. NOAA forecasts are closely watched by insurers, investors, and property owners for obvious reasons. After a number of active years, most everyone would like a boring season for 2009.

Financial innovation knows no bounds and it is now possible to trade “hurricane contracts” on exchanges. Forbes published an interesting article outlining some of the features of these contracts. While the first trading in hurricane-related contracts occurred last year, there are now ways to bet on hurricane activity in much more granular ways:

Contracts come in a variety of flavors. You can get coverage against a storm of specific size hitting one of seven geographic areas. Or you can bet on the severity of the season. Convinced that four Ike-size storms are brewing? You might buy a “seasonal aggregate 40″ contract–$2,500 premium for a payout of $10,000 when the CHI values of the season’s named storms surpass 40 points.

Then there are contracts tied to individual storms. Trading in these will pop when Ana, Bill and Claudette (this year’s names) form. CHI values and contract pricing for name storms will be updated constantly until the storm has made landfall. Trading will continue until the contracts settle, usually within 36 hours of landfall.

The “CHI Index” referenced in the article incorporates new ways of categorizing hurricanes that go beyond the primitive Saffir-Simpson scale which is based only on wind-speed rather than other factors such as storm diameter, which can also impact losses.

It will be interesting to see how the season plays out and whether there will be political backlash against speculators who bet on an active season and financially profit from such transactions.

Comments

[Wesley Mouch:]

Thanks for the information Ravi.

The article fully illuminates what is wrong with our current group think. Using a market structure to predict hurricans? Really? Breaking this down, we are going to take a group of human beings, all of whom have no insight (weather conditions in one month will approach randomness) into hurricane future conditions, and have them wager on future hurricanes. The sum of ignorance is something else than ignorance?

All of that is fine and good, but why then do we expect a market structure to work for any other system? Because market participants have some knowledge (many have insider information not available to the public. Snap! did he just say that? How can that be? CNBC told me that markets were divine, and free market capitalism is the best path to prosperity), and take positions accordingly. If we talk ourselfs into thinking that weather futures are a good idea, it will reinforce my belief that the only real winner will be the firms that facilitate the market.

Jul 30 08:25 AM

[whidbey:]

Actually this is what the insurance companies have been doing for sometime, betting on hurricanes. And they make a killing in many years too. But they are often terribly wrong and... pay for it too.

Why should anyone care if there is a market in weather phenomena? My god we race horses, and bet on them..Start there if the mush heads are seeking another attack on the history of mankind.

Jul 30 01:05 PM