Hurricane Futures Start Slow, Awaiting Atlantic Action

Users of the CME Hurricane Index futures market await first tropical storms of 2010 season to lay off risk.

By MATTHEW BRODSKY, senior editor/Web editor of Risk & Insurance®

We've heard the forecasts for this year's hurricane season. The drumbeat of doom coming from tropical storm prognosticators has been building up to the June 1 start of the season.

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If you were to believe in the predictive powers of futures markets--to channel the collective wisdom of the crowd--then you would expect the CME Hurricane Index futures market to reveal a pattern of fear.

Yet not so. Currently, 1,650 trades have been executed on the futures and options market at the Chicago-based CME Group.

"We're off to a bit of a cautious start," said Paul Peterson, director of commodity research and product development at the CME.

Last year, the notional value of all trades on the CME Hurricane Index market reached about $40 million across 4,000 executed trades.

Peterson suspects that the "cautious" start could in part be caused by the quiet of last year's hurricane season. Only three hurricanes formed in the Atlantic Basic in 2009, with no U.S. hurricane landfalls.

He also suggested that human nature is at play here. Many of the end users that traditionally deal on the hurricane futures market--a mix of reinsurers, primary carriers and some energy companies--have not gotten around to laying their positions yet.

But when 2010's tropical storms start churning off the African coast or in the Caribbean, aiming Mother Nature's wrath at the U.S. Gulf or Atlantic coasts, look out.

"At the first sign of some real activity, we're going to see a surge of business," Peterson said.

Market participants can lay off risks from their books in multiple ways on the CME Hurricane Index futures market. For instance, they can deal on individual named storms. They can place a hedge on a seasonal aggregate loss or a seasonal maximum loss for the largest storm to make landfall. They can lay off a second seasonal event. Or they can lay off a risk for a given coastline. Recently, the market has allowed geographic combinations, the latest being the Florida coast plus the southern and northern Atlantic coasts.

This latest combination came about because of customer demand, according to Peterson, who expects a couple trades to be done with it shortly.

When a contact is triggered by a hurricane making landfall or the season coming to an end November 30, final settlement and payout occur within two business days, getting cash in the hands of the people who need it, said Peterson.

June 8, 2010

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