October 28, 2009

New Options to Manage Exposure to Snowfall

The Chicago Mercantile Exchange (CME) announced that it will offer options contracts to manage exposure to snowfall.  The contracts will be available on 7 December ‘09 for the following snowfall locations:

New York LaGuardia Airport
Chicago O'Hare International Airport
Minneapolis/St. Paul Airport
Detroit Metro Airport
New York Central Park
Boston Logan International Airport

This may seem strange  to some but we would consider this a welcome development.  In fact, it has been the CME’s noted strategy to offer more non-financial futures and options contracts. By bringing these derivatives onto the exchange rather than having the contracts written directly by investment banks the investing public should regain some confidence that in the event of another crisis, their contracts and hence their exposure can actually be guaranteed.

Even a decade prior to last year’s credit crisis, companies like Enron were notoriously exposed to off-exchange derivatives by making markets in all sorts of contracts including weather futures.  In the absence of an exchange that can handle the settlement and counter-party risk, investors and institutions entering into these contracts incur much greater risks of default by their underwriters.  There is a downside to bringing this contracts onto the exchange.   Exchange listed contracts have to be standardized and may not be ideally suited for the needs of some investors.  However, with exotic products such as weather futures, one would think that less flexibility as opposed to potential default risk may be the lesser of two evils.

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