MEANING:

Weather derivatives are financial

instruments that can be used by
organizations or individuals as part of a
risk management strategy to reduce risk
associated with adverse or unexpected
weather conditions. The difference from
other derivatives is that the underlying
asset (rain/temperature/snow) has no
direct value to price the weather
derivative.
There are 4 major players in the weather derivates
market :

• MARKET MAKERS
• BROKERS
• INSURANCE AND REINSURANCE COMPANIES.
• END USERS such as Gas and power marketers
and utilities etc
 Weather Measures

• Weather measures are considered underlying

assets of the weather derivatives, as the price
of a futures contract is an asset for an option
on a commodity.
• The two most common weather measures are
– Heating Degree Days (HDD) or Cooling
Degree Days (CDD) – depending on the
specifics of the contract.
Other measures are based on
precipitation, which can be
measured by the amount of rain
over a given time period or on
Snowfall, measured by the amount
of snow (or sleet) over a given time
period.
 HDD and
CDD
These weather measures are used to measure the demands that arise due
to the departure of the average daily temperatures from a base level.

An HDD (or CDD) is the number of degrees the day’s average temperature
is above (or below) a base temperature. They are calculated as follows:

Daily HDD = Max (0, base temperature – daily average temperature)

Daily CDD = Max (0, daily average temperature – base temperature)

Where,

Base temperature is defined as, the pre-defined base temperature, and,

Daily average temperature is measured as the average between the daily

high and the daily low.
 Weather Derivatives in India

Weather derivatives have been launched

in India as well. Here the major customers will
be the farming community. We don’t see a
huge potential for the derivatives by utility
companies as India is a power shortage nation
and we don’t see the chances of excess power
due to cooler summers or warmer winters.
 Reasons

• Farmers
– Agriculture credit off-take in ninth plan – Rs.
2,31,798 crores (grew @ 20% pa); Target for X
plan – Rs. 7,36,570 crores.
– 90% crop losses on account of weather related
risks
– Rural Economy is highly weather dependent
• Commodity Traders

– Weather related supply bottlenecks

make dry-land commodities very volatile
– Intraday volatility of Guar, chilly touches
10-15% (daily trading at national
exchanges touches Rs.1000 crore daily)
– Vegetable and fruit Mandis highly
dependent on temperature (Delhi Mandi
trade alone touches Rs.1000 crore
annually)
– Trader income dependent on weather
vagaries
• Industries like agro-input companies,
food processing industry, companies,
plantations, FMCG, Banks, Power
sector etc.
• Not uncommon to find Agri-Input
companies, whose sale dips by over
30-40% due to fluctuation in rainfall