Strategies · Library · Weather, energy, inflation
§14.3Hedges and structures
Weather risk – demand hedging
Businesses whose sales depend on temperature hedge with futures or options on heating or cooling degree days, which measure how far daily average temperature is below or above 65 F. The hedge size comes from how strongly weather-affected demand moves with the index.
- Asset class
- Weather, energy, inflation
- Held for
- Varies
- Data
- Needs data ARCANE lacks
- Symphony
- Cannot be built as a symphony
The rule
- Signal
- Cumulative heating or cooling degree days over a week, month or season.
- Entry and exit
- Buy or sell futures or options before the season; settle at the end of the period.
- Sizing
- Size set by how demand co-moves with the degree-day index relative to the index's variance.
How it fails
- Demand not fully weather-driven
- Thin markets
- Forecast error
Data it needs
- daily temperatures
- weather derivative prices
- company demand data
ARCANE has ENSO and storm series but no temperature indexes or weather derivatives.
How ARCANE uses it
A Call about energy demand or a utility could use degree-day forecasts as background.
Needs temperature indexes and derivatives; UNG or XLU rules on weather would be a different strategy.
Source: Kakushadze and Serur (2018), 151 Trading Strategies, §14.3, p. 107 of the SSRN version. Described in our words. Hedges and structures is ARCANE’s filing, not the book’s.