Weather Derivative
Categories: Derivatives, Investing
You can bet on a lot of stuff in financial markets. Stocks and bonds, obviously. Currencies. Commodities (oil and gold, but also more esoteric stuff, like pork bellies). Even casinos. And weather.
No, you can’t actually buy shares in a snowstorm. It works more like a prop bet in Vegas. You buy a contract that pays off if there is less than 35 inches of rain in Iowa during the year.
Why would you buy such a contract? Maybe a crippling gambling addiction. But also, you might be a farmer in Iowa.
If you're a farmer and get less than 35 inches of rain, your crop will fail. Then Old Man Potter down at the bank will foreclose on the farm. So you buy the weather derivative as a hedge. If the rain falls short, your bet on low rain will pay you enough to keep the farm going.
Think: Corn Life Insurance.