A weather derivative (specifically a degree day option) that gives the holder the right, without the obligation, to trade (buy or sell) a weather-related underlying asset, namely the heating degree day (HDD) index. The HDD measures the heating demand that arises by downward diversion of average daily temperatures from a base level. More specifically, the HDD is the number of degrees by which the day’s average temperature is below a base temperature.

The option’s payoff is usually defined as a specified amount (e.g. USD1000 per degree day) multiplied by differences between the strike HDD level set out in the contract and the actual cumulative HDD level which was observed during the option’s life.