degree day swap

Hedging arrangement under which two parties exchange their cash flows at the end of a specified period based on the difference between the negotiated average degree days (the strike level) and the actual degree days (as evidenced by a temperature index) in that period. For example, a gas company expecting reduced revenue due to a forecasted warmer-than-normal winter sells a heating degree day (HDD) swap at a strike level of 1000 HDDs for the winter months (the swap period), to settle at $10,000 per degree day. At the end of the swap period, the company pays $10,000 for every degree day less than 1000 and receives $10,000 for every degree day higher than 2000. It is a type of weather derivative, pioneered by the US firm Enron energy corporation and traded first time in September 1997 between it and another US firm, Koch Industries.