The original purpose of futures contracts was to help farmers hedge against price movements for commodities. Nowadays, the industry has expanded to include many more players.
Futures are contracts that allow the holder to buy or sell a physical asset or financial instrument on a set date at a set price. Within the futures umbrella is a subset of contracts called “exotic” futures, which are traded based on more complex conditions such as political events or the amount of rain that falls in a certain city, etc.
“A lot of them sprang out of the fact that there were informal markets,” a trader and futures specialist told Business Insider. “Even 20 years ago, you’d have people who would basically want to make markets on how many inches of snowfall we’ll get. And someone will trade with that.”
These “exotic” futures, however, serve an actual economic purpose—which sets them apart from casual gambling—and allow individuals and businesses to hedge their risk to conditions like freaky weather. They’re also regulated through clearinghouses, which assure that the two parties in the contract both deliever.
We rounded up some of the more quirky contracts that can be traded as futures. Some are no longer allowed—banned under Dodd-Frank—but most are still traded on exchanges these days.
The amount (inches) of snow and rain that falls in a specific area can be traded as a futures contract or option. Contracts can be traded for snow and rain at various geographical locations, usually designated by a major airport in a city. Rain/snow futures are traded on the Chicago Mercantile Exchange.
Snowfall and rainfall futures can be used by utility companies, transportation services, mail operations, farmers, etc to hedge their risk against excess snow or rain. It can also be used by companies that provide services such as sprinkling salt on roads to hedge risk against light snow.
The Policy Analysis Market was a proposed futures market where contracts on political developments in the Middle East could have been traded.
It was developed by the Department of defence and based on research by George Mason University economist Robin Hanson. At one point, some officials claimed that contracts on events such as coups d'état, assassinations, and terrorist attacks could also have been traded. The developers believed that by tracking how the contracts traded they could gauge behaviour and the actual possibility of an attack on the U.S.
Due to its controversial nature, the development of the Policy Analysis Market was canceled and it was never approved. The Dodd-Frank Bill also banned all futures trading based on events such as assassinations.
For political events futures, individuals can buy contracts for a certain candidate to win the presidency. The contracts are binary options, meaning they pay out a set amount if the election of the candidate occurs, or zero if the candidate loses. The prices of the contracts will fluctuate based on the candidates' perceived possibility of winning the election. For example - the price of a contract for Mitt Romney winning the 2012 presidential election will increase if he actually secures the Republican nomination.
Currently, political contracts can be traded on the Iowa Electronics Markets, which is an educational exchange run by the University of Iowa. The North American Derivatives Exchange has submitted a proposal to the Commodity Futures Trading Commissions to allow trading of politician events contracts, but that is currently under review. Nadex has argued that the contracts provide an economic benefit because it is a political forecaster.
Hurricane futures are traded on the Chicago Mercantile Exchange based off the CME Hurricane Index (CHI)--which is a measurement of hurricane damage based on data from the National Weather Service.
There are futures contracts based on the CHI of each named hurricane and contracts created from the hurricane damage to a certain geographical area.
Hurricane futures can be used by business owners, insurance companies, utility service providers and individual homeowners to hedge their risk to a calm or turbulent hurricane season.
Futures contracts based on how much box office revenue a movie takes in within a set amount of time (a week to a month) were at one point proposed for CFTC approval to be traded on the Cantor Exchange (part of Cantor Fitzgerald) and Trend Exchange. Proponents of the box office contracts said the they could be used by movie studios, DVD rental companies and movie theatres to hedge risk if a movie flops.
Unfortunately, some Hollywood studios--fearing insider trading or a rival studio trying to sway public sentiment by manipulating the market--lobbied Congress heavily and futures based on box office revenue was inserted into the Dodd-Frank act last minute to be banned, a futures industry specialist told Business Insider.
Source: Bloomberg, BI Interview
Futures can be traded based on the average temperature in certain geographical areas designated by the Chicago Mercantile Exchange. The temperatures are indexed and averaged into monthly and seasonal values.
Businesses like heating services, air conditioning manufacturers or utility companies can use the temperature futures to hedge their risk against a oddly warm winter or a possibly chilly summer.
Contracts based on the price of transporting cargo are traded to allow shipping companies and companies that export or import materials to hedge against the risk of increasing prices of shipping goods. The contracts are called forward freight agreements (FFA). These FFAs can be traded in London on the Baltic Exchange.