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Can You Get Rich Betting on the Weather?

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Did you know that you can invest in the weather? Yes, that’s right. The weather. You can take a financial gamble that the temperature in Sacramento will be one degree warmer than average, or even bet that it will be five degrees cooler.

Too dull for your portfolio?

How about putting some money down on the amount of snowfall next winter in Boston? Or frost in Amsterdam? Or hurricanes in the Gulf of Mexico?

Each of these investments can be made in an investment product category called weather futures. Traded through the Chicago Mercantile Exchange, these weather contracts provide investors a highly risky and speculative chance to control – financially at least – that most uncontrollable matriarch, Mother Nature.

Not quite sure how on Earth this could possibly work? Don’t worry, you’re not alone. Let’s start at the beginning.

How Futures Work: A Case Study Using Captain Crunch

At their heart, weather futures trade just like commodity futures. Commodity futures are the backbone of economic trading system surrounding goods like oil and lumber and pork bellies.

So how does a basic futures contract work? Well, let’s say that you are Captain Horatio Magellan Crunch, retired naval hero and maker of a popular eponymous breakfast cereal. To make your delicious crunchy nuggets, you need about 100 tons of corn per month. Let’s say that you’re worried about the increasing use of corn-based Ethanol in large commercial vehicles driving up the cost of corn and subsequently cutting into your profits. Buying a futures contract lets you lay claim to some of next season’s corn now while prices are still relatively low.

A futures contract is, at its simplest, a financial tool that allows you to do the equivalent of licking the last piece of pizza so that the other kids can’t have it. It’s a way for consumers to claim dibs on goods before they’re ready to use them. By putting a little extra money down now, you can lock in a date and a price for the goods you want, and hedge against the risk of the price going up in the future.

So, let’s say you, the Captain, want to lay claim to about 1,200 tons of corn for next year’s production. You would buy a futures contract promising to pay a specified price per ton for delivery on a specific date. For example, the contract might state that you will pay $100 per ton for 1,200 tons on Jan 1 of 2010. Your up-front cost for the contract is $3 per ton, or $3,600, not a deposit on the future purchase mind you, but the cost you pay to lock in the future price today. You’re willing to pay a little extra ($103 total per ton rather than the going rate of $100) because you’re worried about the price of corn going up.

If corn goes up to $200 per ton by January, you’re thrilled because you’ve got the right to buy it at only $100. You’ve saved yourself almost $100 per ton. But if it goes down, you’ve wound up costing yourself more than if you had done nothing at all. You’ll sell the contract at an almost total loss and be out most of the $3600.

The same financial principles are at stake when your old college roommate options his blockbuster screenplay to Paramount. Because getting a film from page to screen is such a long and iffy process, and because most films that get pitched never wind up being made, studios and producers prefer to option a screenplay rather than buy it outright, reserving the right to buy the script when the picture actually gets greenlighted. An option contract of this type might simply state that Paramount reserves the right to buy your buddy’s script anytime within the next year for $1 million dollars.

For this option, they’re willing to pay your old roommate $5,000. Paramount is not promising to buy the script, they’re just keeping the scavengers from Miramax from buying it up during the next year while they try to firm up Mandy Moore for the leading role.

If a year goes buy, and Paramount decides that they’re not going to make the picture, your friend can go shop his script to the other studios. Some scripts are optioned ten times before the film actually gets made.

From Ancient Babylon to Ralph Bellamy: The History of Futures Trading

Archeological evidence points to some type of futures contracts being in use as long ago as 6000 B.C. in China. Other evidence shows rudimentary clay tablets in Babylon with carvings of sheep and grains on them, suggesting a basic type of promissory note obligating delivery of market produce to the bearer of the tablet.

The first standardized and documented use of these contracts goes back to 17th century Japan, where those who had stores of rice in their warehouses would sell receipts against the rice to raise cash. These “rice tickets” came to be used as an informal currency, changing hands dozens of times before the rice was actually claimed.

Throughout the 17th and 18th centuries, commodity exchanges popped up wherever trade and transportation were an issue: London, Amsterdam, Paris, and New York – with the granddaddy of them all, the Chicago Board of Trade, opening in 1848. It was there, nestled in the city that Carl Sandburg labeled the “hog butcher of the world,” that simple agricultural markets would go from the hands of farmers and merchants into the pockets of hedge fund managers and high-risk traders, and eventually into the plot of the movie Trading Places.

In the 1983 buddy movie, Eddie Murphy and Dan Akroyd use a dummied-up crop report to get the Duke brothers (exquisitely played by Ralph Bellamy and Don Ameche) to run up the price for frozen concentrated orange juice (FCOJ) futures. The Duke brothers wind up going broke on the gamble and Murphy and Akroyd make enough from the scheme to buy their own island.

Weather Investing: Money Between the Raindrops

These days, you can buy and sell contracts for wheat, milk, cattle, soybeans, pork bellies, lumber, and a dozen more subgroups of commodities. You can also trade futures on financial indexes like the Dow Jones Industrial Average, foreign currencies, and of course, weather events.

Simple temperature contracts cover temperature changes in 25 cities in the U.S. and Canada, and another dozen or so in Europe, Asia, and Australia. There are also contracts that cover frost, snow, rain, and hurricanes.

For the basic temperature contracts, a trader can pay a premium to another trader, the seller, for an option that lets him wager on future temperatures. If the temperature hits a specified level, the buyer collects an agreed-upon amount from the seller. If it doesn't, the seller keeps the premium and the contract expires. The whole thing is based on units called “degree days.” Temperatures are calculated daily from a baseline of 65 degrees Fahrenheit (18 degrees Celsius.) Each degree below 65 counts as one "heating degree day," the designation originally developed for utilities to calculate demand. A temperature of 50 degrees, for instance, counts as 15 HDDs. In summer, cooling degree days are calculated from the same 65-degree baseline.

You might ask what possible real-world application these contracts might have other than pure speculation. It turns out that in the right hands, these contracts can be quite useful. For example, in the United Kingdom, utility companies estimate that a one-degree temperature change causes a 5% swing in natural gas demand. If you’re a utility or a natural gas consumer of great quantity, you might want to purchase a hedge against the possibility of the run-up on the price of gas. Or, if you’re a huge consumer of oil refined in the Gulf of Mexico, then you’d be pretty interested in buying hurricane futures since large storms typically bring chaos to oil prices.

Also, if you own a ski resort or a golf course, the weather can make or break your business. An ordinary insurance company won’t sell you a policy based on rainfall, but you might be able to make some money on a rainfall investment to offset the loss you take when a downpour comes along and washes out the 15th fairway.

The Enron Corp. is responsible for selling the first weather derivative 10 years ago, agreeing to pay a utility $10,000 for each wintertime degree that was below normal. After a lull following Enron’s historic flameout, the weather trading market has taken off. Trading in weather contracts jumped 100-fold from 2003-2007, according to the Chicago Mercantile Exchange. This was due, in no small part, to hedge funds.

Some estimates put hedge fund speculation at over 50% of the $19 billion weather futures market. That means that instead of the farmers, oil rig operators, baseball stadium owners and other parties that have a direct relationship between their business and the weather, the majority of weather trading is done by speculators. This trend has been seen in almost every commodity market. Whether oil spikes or corn speculation, investors are taking over markets that were once the bailiwick of farmers and rural bankers. Or at least they were.

With the current economic downturn, futures trading volume was down 46% in 2008, with weather contracts down 54% as a group. With difficult times ahead, and the distinct possibility that exotic derivative products are partly to blame, many traders have gone back to basics.

And it’s no wonder. A recent study at Penn State pitted two distinct groups against each other in a weather trading simulation to see which would be more successful. According to the study’s press release, “the results so far show the market to be far more profitable for traders who are studying meteorology than those who are studying business.”

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iStock // Ekaterina Minaeva
Man Buys Two Metric Tons of LEGO Bricks; Sorts Them Via Machine Learning
May 21, 2017
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iStock // Ekaterina Minaeva

Jacques Mattheij made a small, but awesome, mistake. He went on eBay one evening and bid on a bunch of bulk LEGO brick auctions, then went to sleep. Upon waking, he discovered that he was the high bidder on many, and was now the proud owner of two tons of LEGO bricks. (This is about 4400 pounds.) He wrote, "[L]esson 1: if you win almost all bids you are bidding too high."

Mattheij had noticed that bulk, unsorted bricks sell for something like €10/kilogram, whereas sets are roughly €40/kg and rare parts go for up to €100/kg. Much of the value of the bricks is in their sorting. If he could reduce the entropy of these bins of unsorted bricks, he could make a tidy profit. While many people do this work by hand, the problem is enormous—just the kind of challenge for a computer. Mattheij writes:

There are 38000+ shapes and there are 100+ possible shades of color (you can roughly tell how old someone is by asking them what lego colors they remember from their youth).

In the following months, Mattheij built a proof-of-concept sorting system using, of course, LEGO. He broke the problem down into a series of sub-problems (including "feeding LEGO reliably from a hopper is surprisingly hard," one of those facts of nature that will stymie even the best system design). After tinkering with the prototype at length, he expanded the system to a surprisingly complex system of conveyer belts (powered by a home treadmill), various pieces of cabinetry, and "copious quantities of crazy glue."

Here's a video showing the current system running at low speed:

The key part of the system was running the bricks past a camera paired with a computer running a neural net-based image classifier. That allows the computer (when sufficiently trained on brick images) to recognize bricks and thus categorize them by color, shape, or other parameters. Remember that as bricks pass by, they can be in any orientation, can be dirty, can even be stuck to other pieces. So having a flexible software system is key to recognizing—in a fraction of a second—what a given brick is, in order to sort it out. When a match is found, a jet of compressed air pops the piece off the conveyer belt and into a waiting bin.

After much experimentation, Mattheij rewrote the software (several times in fact) to accomplish a variety of basic tasks. At its core, the system takes images from a webcam and feeds them to a neural network to do the classification. Of course, the neural net needs to be "trained" by showing it lots of images, and telling it what those images represent. Mattheij's breakthrough was allowing the machine to effectively train itself, with guidance: Running pieces through allows the system to take its own photos, make a guess, and build on that guess. As long as Mattheij corrects the incorrect guesses, he ends up with a decent (and self-reinforcing) corpus of training data. As the machine continues running, it can rack up more training, allowing it to recognize a broad variety of pieces on the fly.

Here's another video, focusing on how the pieces move on conveyer belts (running at slow speed so puny humans can follow). You can also see the air jets in action:

In an email interview, Mattheij told Mental Floss that the system currently sorts LEGO bricks into more than 50 categories. It can also be run in a color-sorting mode to bin the parts across 12 color groups. (Thus at present you'd likely do a two-pass sort on the bricks: once for shape, then a separate pass for color.) He continues to refine the system, with a focus on making its recognition abilities faster. At some point down the line, he plans to make the software portion open source. You're on your own as far as building conveyer belts, bins, and so forth.

Check out Mattheij's writeup in two parts for more information. It starts with an overview of the story, followed up with a deep dive on the software. He's also tweeting about the project (among other things). And if you look around a bit, you'll find bulk LEGO brick auctions online—it's definitely a thing!

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Sponsor Content: BarkBox
8 Common Dog Behaviors, Decoded
May 25, 2017
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Dogs are a lot more complicated than we give them credit for. As a result, sometimes things get lost in translation. We’ve yet to invent a dog-to-English translator, but there are certain behaviors you can learn to read in order to better understand what your dog is trying to tell you. The more tuned-in you are to your dog’s emotions, the better you’ll be able to respond—whether that means giving her some space or welcoming a wet, slobbery kiss. 

1. What you’ll see: Your dog is standing with his legs and body relaxed and tail low. His ears are up, but not pointed forward. His mouth is slightly open, he’s panting lightly, and his tongue is loose. His eyes? Soft or maybe slightly squinty from getting his smile on.

What it means: “Hey there, friend!” Your pup is in a calm, relaxed state. He’s open to mingling, which means you can feel comfortable letting friends say hi.

2. What you’ll see: Your dog is standing with her body leaning forward. Her ears are erect and angled forward—or have at least perked up if they’re floppy—and her mouth is closed. Her tail might be sticking out horizontally or sticking straight up and wagging slightly.

What it means: “Hark! Who goes there?!” Something caught your pup’s attention and now she’s on high alert, trying to discern whether or not the person, animal, or situation is a threat. She’ll likely stay on guard until she feels safe or becomes distracted.

3. What you’ll see: Your dog is standing, leaning slightly forward. His body and legs are tense, and his hackles—those hairs along his back and neck—are raised. His tail is stiff and twitching, not swooping playfully. His mouth is open, teeth are exposed, and he may be snarling, snapping, or barking excessively.

What it means: “Don’t mess with me!” This dog is asserting his social dominance and letting others know that he might attack if they don’t defer accordingly. A dog in this stance could be either offensively aggressive or defensively aggressive. If you encounter a dog in this state, play it safe and back away slowly without making eye contact.

4. What you’ll see: As another dog approaches, your dog lies down on his back with his tail tucked in between his legs. His paws are tucked in too, his ears are flat, and he isn’t making direct eye contact with the other dog standing over him.

What it means: “I come in peace!” Your pooch is displaying signs of submission to a more dominant dog, conveying total surrender to avoid physical confrontation. Other, less obvious, signs of submission include ears that are flattened back against the head, an avoidance of eye contact, a tongue flick, and bared teeth. Yup—a dog might bare his teeth while still being submissive, but they’ll likely be clenched together, the lips opened horizontally rather than curled up to show the front canines. A submissive dog will also slink backward or inward rather than forward, which would indicate more aggressive behavior.

5. What you’ll see: Your dog is crouching with her back hunched, tail tucked, and the corner of her mouth pulled back with lips slightly curled. Her shoulders, or hackles, are raised and her ears are flattened. She’s avoiding eye contact.

What it means: “I’m scared, but will fight you if I have to.” This dog’s fight or flight instincts have been activated. It’s best to keep your distance from a dog in this emotional state because she could attack if she feels cornered.

6. What you’ll see: You’re staring at your dog, holding eye contact. Your dog looks away from you, tentatively looks back, then looks away again. After some time, he licks his chops and yawns.

What it means: “I don’t know what’s going on and it’s weirding me out.” Your dog doesn’t know what to make of the situation, but rather than nipping or barking, he’ll stick to behaviors he knows are OK, like yawning, licking his chops, or shaking as if he’s wet. You’ll want to intervene by removing whatever it is causing him discomfort—such as an overly grabby child—and giving him some space to relax.

7. What you’ll see: Your dog has her front paws bent and lowered onto the ground with her rear in the air. Her body is relaxed, loose, and wiggly, and her tail is up and wagging from side to side. She might also let out a high-pitched or impatient bark.

What it means: “What’s the hold up? Let’s play!” This classic stance, known to dog trainers and behaviorists as “the play bow,” is a sign she’s ready to let the good times roll. Get ready for a round of fetch or tug of war, or for a good long outing at the dog park.

8. What you’ll see: You’ve just gotten home from work and your dog rushes over. He can’t stop wiggling his backside, and he may even lower himself into a giant stretch, like he’s doing yoga.

What it means: “OhmygoshImsohappytoseeyou I love you so much you’re my best friend foreverandeverandever!!!!” This one’s easy: Your pup is overjoyed his BFF is back. That big stretch is something dogs don’t pull out for just anyone; they save that for the people they truly love. Show him you feel the same way with a good belly rub and a handful of his favorite treats.

The best way to say “I love you” in dog? A monthly subscription to BarkBox. Your favorite pup will get a package filled with treats, toys, and other good stuff (and in return, you’ll probably get lots of sloppy kisses). Visit BarkBox to learn more.