Trading in Fantasy
IN the 1950s, onion growers were often shocked at the low prices they were getting. Casting around for a villain to blame, they alighted on derivatives traders, and they persuaded Congress to ban any futures trading in onions.
Today onions are the only commodity for which futures trading is banned. Not coincidentally, onion prices remain extremely volatile: they doubled in 2008, and then fell by 25 percent in 2009.
Today, no one is silly enough to ask a member of Congress to simply outlaw futures trading in a certain type of contract — no one, that is, except Hollywood film producers. Under the proposed financial-reform legislation making its way through the Senate, the bit of the 1958 bill saying “except onions” would be amended to read “except onions and motion picture box office receipts.”
Hollywood was scared into pushing for the new language after the Commodity Futures Trading Commission, which regulates futures trading, recently approved two applications for markets in contracts based on movie grosses. But if the new provision makes its way into law, the biggest losers will be the very film producers who lobbied for it.
The proposed contracts are simple: they would allow traders to bet on the total box-office receipts of movies in their first four weeks of release. A contract on “Iron Man 2,” for instance, might be trading at $390, meaning that the market is expecting the film to gross $390 million in its first four weeks. If you think it’s going to make more than that, you would go long, or buy the contract; if you think it’s going to make less, you would go short, or sell it. At the end of the four weeks, the contract would expire at whatever the four-week gross is. If you went long at $390 and the film ended up earning $450 million in its first four weeks, then you’d make $60 for every contract you bought.
Hollywood’s mouthpiece, the Motion Picture Association of America, has argued that the new market could tarnish “the reputation and integrity of our industry” and would constitute “unbridled gambling” — though there’s nothing “unbridled” about the regulatory strictures involved in being listed on a Chicago commodity exchange.
The real reason most of Hollywood is opposed to this development is unclear, but it is probably simply the age-old story of large, conservative institutions being averse to change. Top executives at the biggest studios may suspect that smaller and nimbler competitors would get more benefit out of such a market: it’s easier to hedge a $10 million project than a $200 million one.
Yet as Lionsgate Films, one of the few studios supporting the market, has recognized, a futures contract on box office receipts would be great news for the industry. For one thing, if the market got big enough, it would allow studios to easily hedge their investments in movies just by entering into a simple derivatives transaction. Studios could essentially sell contracts on their movies’ grosses into the open market, and pocket the proceeds. They would lose money on the contract if the movie does well, but in that case they’d make enough money on the movie itself to cover their derivatives losses.
That kind of thing would be a lot easier, and a lot cheaper, than the studios’ current methods of trying to hedge exposure and sell risk: the financing arrangements behind a typical Hollywood movie, with countless co-producers and incomprehensible accounting, make the average collateralized debt obligation look simple and transparent.
And even if the studios didn’t participate in the market, they would still benefit. People care much more about things they bet on, and the fake-money version of these contracts — the online Hollywood Stock Exchange, in operation since 1996 — has done wonders for increasing awareness of coming films among its users, without a single dollar of publicity and marketing money being spent.
What’s more, the contracts for the proposed market would be based on the first four weeks of box-office results, not just the opening weekend. A lot of people, of course, would be betting on that opening-weekend number, which is more a function of hype than a movie’s long-term chances of success. Just as many, however, would wait until the movie comes out, watch it on its opening weekend, make their own qualitative determination of how well it will continue to perform over the rest of the month and then place their bets accordingly.
Hollywood has an entirely predictable predilection for shooting itself in the fiscal foot, so none of this should come as a surprise. But it is sad that the most intriguing derivatives product to be approved in years will probably be banned by Congress — thanks to the very people who stand to benefit the most from it.