We call our friends and many times ask “How is the weather?” Did you ever think that speculating on the weather might be an interesting play? Well now you the trader can place binary option plays on hurricanes through the Chicago Mercantile Exchange “CME” Hurricane Index™ futures and options products. These binaries are similar to other binary options, with strike (exercise) prices on a wide range of CME Hurricane Index values. Like traditional binaries, they provide the option holder with a fixed dollar payout upon exercise and are offered only as “calls” since “puts” would result in a payout on an event that failed to occur. These calls are based on the CME Hurricane Index (CHI™ ), a proprietary index that provides a numerical measure of the potential damage arising from a hurricane in the USA.
Using readily available data from the National Hurricane Center of the US National Weather Service, the CHI calculates the potential for damage for each official storm by reference to its maximum wind speed and size (radius). The CHI tracks storms in designated areas in the Gulf of Mexico and the eastern seaboard of the United States, from their origin until the end. The independent index determines whether a particular event triggers the payout, provides more transparent pricing, and rapid payouts following a triggering event. The counterparty performance of the option call writer is guaranteed by CME Clearing.
The benefits from these options are: a simplified hedging process for anyone with hurricane exposure, a substitute for creating complex call option spreads, a way to precisely match dollar exposure to a specific number of binary contracts, in $10,000 increments with convenient contract multiples and small pricing increment, and, finally, greater pricing precision, since premiums can be traded in $1 increments. The binaries are offered on Index (named storm), Seasonal (aggregate), Seasonal Max (largest storm of the season) and
Seasonal Max Binary futures contracts. Thus the contract size is $10,000, with minimum price increment or tick value of 0.01 point = $1. You the call buyer will receive $10,000 if the respective CHI value is equal to or greater than strike price, but unfortunately you will receive nothing if the respective CHI value is less than the strike price. There are also separate binary contracts listed for trading on named hurricanes making landfall in a specific geographic location (e.g., Eastern U.S.) between January 1 and December 31 of a specified calendar year. At the beginning of each season, storm names are used from a list, starting with A and ending with Z, maintained by the World Meteorological Organization. The named hurricane must also make landfall in the Eastern U.S. (Brownsville, TX to Eastport, ME), or must occur within the CHI-Cat-In-A-Box – Galveston-Mobile (area bounded by 95°30’0”W on the West, 87°30’0”W on the East, 27*30’0”N on the South and the corresponding segment of the U.S. coastline on the North). In fact, there are 9 different locations specified by the CME within this specified area. The binaries will terminate trading at 9:00 A.M. on the first Exchange business day that is at least five calendar days following the last forecast/advisory issued by the National Hurricane Center (NHC) for the named storm.
So as a trader, if you believe that you have a sense of the weather pattern for the US for 2013, and want to place larger sized trades, and thus receive larger payouts, then you can buy a binary call for a storm hitting perhaps Washington DC. Looking at the last few years, we have seen New Orleans, New York, and North Carolina hit by storms then perhaps the upcoming year will see a “different storm” hit the capital of the USA.