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Monday, October 11, 2010

Hollywood v. Wall Street

As a follow up to my June post on the battle between Wall Street and Hollywood regarding the trading of box office futures contracts, an explanation of how these financial derivatives are traded and who would benefit or not from their implementation is necessary for movie exhibitors to understand.

HOW FUTURES CONTRACTS WORK

Each movie has it own contract. The price of that contract is based upon the current market consensus of how much a particular movie will earn over the first four weeks of its initial release. Investors profit from either their prediction on the success of the movie (buy long) or its anticipated limited gross (sell short).

Contract pricing is based on 1/1,000,000th of the total Domestic Box Office Receipts collected during the first four weeks after the movie's release. If the movie exhibits longer, any ticket sales will not count towards the value of the contract.

So, for example, if the market determines that a movie will bring in $100 million during its first four weeks and an investor believes that it will do $100 million or more they would buy a contract(s) valued at $100 each. On the other side, if they believe the film will not reach its predicted $100 million gross they would sell a contract for $100.

If-in this example-the movie grosses $200 million the contract seller would lose their $100 investment while the buyer would make $100 and double their investment.

There are two exchanges vying to trade box office futures - the Cantor Exchange and the Trend Exchange. They differ in that the Cantor Exchange would allow traders to buy and sell contracts for as little as $50, while the Trend Exchange will require a minimum $5,000 investment.

Proponents of allowing trading in box office futures believe that it would help Hollywood hedge its losses, essentially offering insurance that would allow risk to be defrayed to traders - similar to a farmer hedging his corn crop. And that such a market would be very useful for, among others, independent movie producers and distributors as they could hedge their movie investment in the event it turns out to "bomb" at the box office.

BENEFIT TO EXHIBITORS

Like the farmer, the movie exhibitor could use the futures contracts as a hedge against a film not producing the box office grosses expected and reaping the benefits of a short seller by selling futures forward. If the movie does not do well the exhibitor benefits by collecting on the contract. If the movie grosses well or even better than anticipated the exhibitor loses the investment on the contract but reaps the rewards from a good box office take. It's essentially buying insurance against a potential risk.

As of today, Hollywood , by active and effective lobbying of the U.S. Congress, has so far prevented the trading in box office futures. However, my guess is that it's just a matter of time before the trading of these contracts becomes reality. There is just too much money at stake in the production and exhibition of movies for it not to happen.

Jim Lavorato