The big thing about Freddy is that he loves Grandpa Otto Binns. He and Grandpa live in Big Blue, a house that sits on top of a hill. Susan, his granddaughter, lives in the back apartment. When Grandpa locks the door of Big Blue to trick-or-treaters, we see that he is a bitter old man. Otto's sisters, Violet and Rose, coax him to knit hats for the Christmas carolers. The problem is that he has only 4 days to finish 15 hats. He only has enough yarn for 1 hat, and there is an impending nor'easter. Cars can't get up the hill in snow.
He completes one hat and, feeling hopeless, tosses the scraps into Freddy's cage. Otto goes to bed and has a nightmare about not finishing the hats. Anxious, Freddy spins on his treadwheel. The red and green yarn scraps get twisted in the treadwheel, creating new yarn. Grandpa Binns discovers this twisted yarn in the morning. Amazed, he knits the hats with it. There were more than enough hats for the carolers, who came to Big Blue to begin their night of caroling. After they left with their new hats, the carolers spread the story of Grandpa and Freddy's twisted yarn.
One year later, Grandpa has become more loving; he welcomes trick-or-treaters to Big Blue.