A temperature derivative in which the weather index buyer and the weather index seller agree to exchange payment obligations contingent upon the total number of cooling degree days (CDDs) or heating degree days (HDDs) for a specific period of time. This exchange involves the cumulative variation of the actual temperature during the period relative to the standard reference temperature. For example, in an HDD Swap, the weather index buyer is expecting cooler than usual weather during the term of the swap (that means a higher number of HDDs), while the weather index seller is foreseeing warmer than usual weather for the same period (that is, a lower number of HDDs).

The settlement level (i.e., the cumulative number of HDDs (or CDDs) during the term of the swap) is used to determine which party is obliged to make a payment under the swap to the other. The settlement level will be compared to the threshold number of HDDs (or CDDs)- known as the weather index level. If, at maturity or during the calculation period (a sub-period into which the term of the swap has been partitioned), the cumulative number of HDDs is lower than the weather index level, then the weather index buyer will be obligated to pay the weather index seller (buyer) an amount equal to the excess of the weather index level over the settlement level multiplied by the notional principal of the swap. In the opposite case, the weather index seller will have to pay the weather index buyer an amount equal to the excess of the settlement level over the weather index level multiplied by the notional principal of the swap.

This swap is also called a weather swap.