Wednesday, July 25, 2007

How To Hedge A Hurricane

Who needs Foxwoods?

...Hurricane futures, which were introduced on the Merc in March, will allow energy traders to hedge risks in their positions and allow speculators to bet on the potential impact Atlantic storms will have. Eventually, reinsurers might be attracted to them as another way to offset risks in their portfolios.

...Suppose the storm starts out at medium strength and many think it's going to strengthen before it makes landfall. A trader who pays $2,000 for a futures contract on a size 2 storm stands to profit $2,000 if the storm makes landfall as a size 4 storm on the scale, or lose the cost of the contract if the storm peters out.

In the same vein, a trader who doubts the storm will keep its strength could sell (or short) the futures contract on a size 2 storm and profit $1,000 if it makes landfall as a size 1 storm.

From Forbes