Chicago, 12 June 2010

The day after CME Group launched a new location to the suite of hurricane derivatives, 1,000 contracts of the new product traded. The deal was executed by TigerRisk Partners, a broker based in Stamford CT. Sources in the derivatives business indicated that the counterparties were two reinsurance companies. CME Hurricane Index (CHI) options are exercised for settlement when hurricanes make landfall on the US mainland.

“CHI is based on a formula that includes the wind speed of a given storm as well as its radius,” explains Scott Mathews, President of WeatherEX, a consultant in capital market alternative investments. “The data that feeds the index calculation is provided by the National Hurricane Center and available to the public,” he adds. The landfall parameters are either by precise coastal borders between states, or by coordinates of longitude and latitude.

The recent transaction has a maximum payout of $10 million that will be triggered if the CHI values for all storms in 2010 making landfall anywhere from Florida to Maine exceed 25 points. For reference, 2005’s Katrina was at 19.0 CHI points when she hit Louisiana, and Rita made landfall at 9.9 CHI. The cumulative element of this Tuesday’s deal means the value of all storms will be added together to determine if the binary call goes “in the money” by the end of the season. The buyer paid the seller $1.9 million for the options, the premium being negotiated as “19 ROL” (rate on line) which means, in reinsurance parlance, 19% of the total coverage amount.

CME started listing hurricane products in 2008 and expanded the instruments in 2009 with the introduction of binary options. “The appeal of binary options,” observes Rodney W. Dow, CEO of The Dow Corporation, is that, “they offer both buyer and seller a pre-set risk-versus-reward ratio.” Mr. Dow’s company is an independent introducing broker specializing in institutional energy business.

“Insurance writers and property policy holders are the natural users of these products in the CME business model, says Mr. Mathews, adding, “yet the greater population of energy traders having correlated risk to storm activity can also use CHI instruments to manage the uncertainty.”

Year to date, the CME’s hurricane deals have totaled $27.5 million in potential payout coverage. This is in contrast to the only other exchange traded windstorm instruments in the futures business which are industry loss warranty contracts listed on the IFEX, a trading platform recently acquired by the ICE from the Chicago Climate Exchange. According to a recent article in Insurance Insider, a UK publication, the “rival” product has traded only $15 million in coverage. Both markets are showing increasing open interest.

“The CME Hurricane Index offers new opportunities for our customers who have traditionally concentrated in one product group to diversify and expand into other trading areas and complementary asset classes with the goal of additional risk mitigation,” said Joe Raia, CME Group Managing Director of Energy and Metals Products and Services.

Mr. Dow, who has been a close follower of hurricane action in the Gulf of Mexico for 30 years, emphasizes how these storms can significantly influence the prices of energy commodities he trades. Referring to times when natural gas volatility increases in reaction to a hurricane forecast, he says “Natgas coupled with CHI options are like the tail and the dog, and now we can actually go for the dog, and not get whipsawed by the tail.”

With predictions of an active hurricane season this year, there could be a whole pack of hounds to chase after.

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