Once a company has made the decision to hedge their weather risk, there are several techniques that can be used to managed the risk. The first alternative is to buy an option--a call option protects the buyer in the case of an “excess” amount of weather, such as too much rain, while a put option protects the buyer in the case of a “deficit” of weather, such as not enough snow. Weather options, unlike traditional equity options, have a strike level based on the relevant measure of weather (actual measures such as temperature, precipitation amounts or indexes like heating or cooling degree days).

If the simple purchase of an option does not provide the exact type of protection desired, more complicated structures, such as a collar, can be implemented. A collar is the equivalent of buying a put option and selling a call option with different strike levels, or selling a put option and buying a call option. The advantage of a collar is that the amount of premium is reduced by sharing potential profits, in effect receiving downside protection and giving up some upside potential.

A third alternative strategy is a swap, which is the equivalent of buying a put option and selling a call option (or vice-versa) with the same strike level and premium. With a swap, one party gets paid if the weather is greater than the strike level, and the other party gets paid if the weather is less than the strike level.