A Recent Development in Futures and Options Markets Are Weather

question 32

Essay

A recent development in futures and options markets are weather derivatives. One example is a weather futures contract based on a heating or cooling index. The settlement process is similar to an index future where cash is paid based upon the difference between the purchase level and the level of the index at expiration. Is this really gambling?

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Definitions:

Opportunity Cost

The cost of foregoing the second-best option when making a decision, representing the benefits that could have been received by taking a different action.

Make-Or-Buy Decision

A decision-making process used by businesses to determine whether to produce goods in-house or purchase them from an external supplier.

Cost Recovery

The process of recouping the costs of an investment, expense, or other outlay of funds, often related to capital projects, taxes, or legal judgments.

Investment

The allocation of resources, usually money, into assets or projects expected to generate future profits or income.