Indexes include degree days built from temperature, as well as rainfall, the number of rainy days, and the number of snowy days. There are two forms. In the option form, the buyer pays a premium and receives a payment based on how far the index ends above the strike (call type) or below it (put type). In the swap form, no premium is paid, and one party or the other pays depending on whether the index ends above or below the reference value.
Unlike insurance, a weather derivative does not assess the loss and pays a fixed amount when the observations meet the conditions. Payment therefore arrives quickly, but it does not always match the actual loss.