Hurricanes are traded in the form of futures contracts along with other weather products. Although you can’t buy or sell a hurricane, there are other reasons that investors invest money in to these monster storms.
Don’t know much about a futures contract and you can’t think of any possible way that investors could possibly trade a hurricane? Keep reading. We’re going to learn everything we need to know about these futures contracts.
Futures Contracts?
Individual investors don’t often delve in to the futures market unless they are buying and selling shares of an exchanged traded fund that track the movement of a certain futures contract. A futures contract is a contract between a buyer and seller where the buyer agrees to buy something at a set price sometime in the future. If somebody were selling corn futures, the seller would agree to sell corn to the buyer at a certain price sometime in the future.
Of course the buyer wants the market price of corn to be higher than his futures contract because he could immediately sell the corn and make a profit. The worst case scenario would be that the buyer has to take delivery of his corn at a price higher than the current market price but that’s the risk of being a futures trader.
Hurricanes are a little bit too big to package up and sell to somebody so how does this hurricane futures contract work? In the investment world, everything is bought and sold including signed contracts. That buyer of corn may not hold his futures contract to maturity. He’ll wait for the value of the contract to rise and sell it to somebody for a profit. This is one way to make money on hurricane futures.
The value of the contract rises as the storm gets closer to making landfall and/or strengthening and the value falls as it moves away from land and/or weakens. Contracts are available for trading once a named hurricane forms and it is settled or terminated when the National Hurricane Center gives its last advisory on the storm.
Who needs it?
Hurricane futures aren’t designed for retail traders to make a profit. Instead, they are often used by insurers, reinsurers, energy traders, and large institutional clients as a hedge. In the investing world, when you hedge something you’re protecting or insuring your money. If a large hurricane is forecast to enter the Gulf of Mexico and strengthen, a person who is short energy (betting that the price will fall) may purchase hurricane futures contracts to hedge his oil position.
If the hurricane strengthens, the futures contracts rise in value and since a strong hurricane could shut down offshore oil rigs, refineries, and shipping lanes, the price of oil or other energy product may rise making his short position in energy drop in value. With his futures contracts rising in value and his short investments falling, his money is protected.
Seem a little complicated? It is and that’s why these types of investments aren’t meant for the individual stock trader. Although it is possible to use hurricane futures as a way to make a profit, they are used primarily as insurance for large, professional traders. This investment product is best left to the pros.