What The Film Trading Places Can Teach Us About the Stock Market

24 December 2018
The climax of the classic 1983 film Trading Places shows the characters played by Dan Aykroyd and Eddie Murphy delivering a comeuppance to the billionaire Duke brothers who have tried to destroy their lives.

The scene, which shows the heroes finally defeating the malicious Dukes on the trading floor, can teach us a few things about how stock markets work.

What is Trading Places about?

In the movie, the wealthy stock trader Louis Winthorpe (Dan Aykroyd) and the petty criminal Billy Ray Valentine (Eddie Murphy) have their positions in society reversed over a $1 bet between the two Duke brothers (Ralph Bellamy and Don Ameche).

Louis is framed as a thief and a drug dealer and ends up losing his job, his home and his fiancée, while Billy Ray is catapulted overnight from a down-on-his-luck conman to a position of luxury, even taking over Louis’ old job and moving into his home.

Eventually, the pair run into each other and realise that they have been played and decide to work together to seek revenge. They learn that the Dukes have stolen an orange juice crop report soon to be released by the US government, and are planning to use it to corner the orange juice futures market. Fortunately, Louis and Billy Ray are able to intercept the stolen report before it reaches the Dukes, and deliver them a fake copy instead.

According to the fake report, a harsh winter has reduced the orange harvest, which will lead to a shortage of oranges that will send prices through the roof. In order to profit from this, the Dukes buy up as many orange juice contracts as they can before the report is officially released, expecting to sell them on at a huge profit later. This drives all the other traders into a frenzy, and the price goes up and up.

However, Louis and Billy Ray know that the winter has not affected the orange harvest, and there will be plenty of OJ to go around. So, they wait until the Dukes have driven the price way up, and then begin selling as many contracts as they can. When the official report comes out, all of the traders, including the Dukes, realise that there is no shortage of orange juice, and are desperate to sell the contracts they had just bought.

Once again, Louis and Billy Ray wait for the price to move, this time way down, before they start buying from the frantic traders. When the final bell tolls, the Dukes have lost their fortunes, and Aykroyd and Murphy’s characters have made more than enough to retire comfortably on their own private tropical island. But what exactly happened on the trading floor?

Futures contracts

The first thing to understand is what everyone is buying and selling in the scene. All the trades in this scene are selling futures contracts for orange juice. Futures contracts set a quantity, date and price for a particular commodity to be delivered at a future time and help to bring certainty to market volatility. Even if circumstances in the future change, the contracts have already set the price.

The traders aren’t interested in keeping the juice for themselves, but instead are buying deliveries from juice manufacturers and selling them to juice sellers, like supermarkets or grocery stores. The traders act as middlemen and hope to make money off the difference between the price they buy at and the price they sell for.

Long and short selling

The Duke brothers are attempting to go long on orange juice futures, while Louis and Billy Ray are implementing a short selling strategy. A long strategy is the traditional way of making money on the stock markets; buying low and selling high. A short strategy is the reverse, selling high and buying low.

The Dukes believe because of the fake crop report that there will be a shortage of orange juice, and the price will therefore skyrocket. So, by buying all the juice available now, when the shortage is revealed, everyone will have to buy it off of them at inflated prices. Louis and Billy Ray, on the other hand, know that there is plenty of juice available, and begin selling contracts at the high price the Dukes have created. Importantly, they are promising to deliver orange juice that they don’t actually own yet, but are planning to buy up the juice they need to deliver after the crop report is released.

Once the official report is made public, all the other traders are desperate to sell, in order to minimise their losses. In fact, they have already made a loss, but if they can sell the juice that they have bought, then they might be able to make back a little of their money. Because the other traders are frantically selling, Louis and Billy Ray can buy very cheaply all the orange juice they need in order to fulfil the contracts they have already made. If they weren’t able to buy the juice they needed, they would default on their promised deliveries, leaving them owing potentially millions of dollars. Short selling can be a profitable strategy, but it is also a risky one.

The Duke brothers’ plan failed because they bought high and sold low, leaving them destitute. The other traders also lost money on the deal, but not quite as much as the Dukes. Louis and Billy Ray successfully short sold millions of dollars of orange juice and retire comfortably.

Insider trading

An important caveat to this scene is that while long and short selling is legal and are popular trading strategies, acting on insider information, like a stolen crop report, is illegal and can result in a very hefty fine or even jail time.

Insider trading involves using information not publicly available to make a profit through trading on the stock market.

This can include knowledge that you learn as an employee of a company that isn’t publicly available, or as a lawyer or accountant receiving privileged information. Insider trading also includes telling your friends or family to make trades based on the insider information you possess.

Interestingly, insider trading wasn’t illegal on the US commodities market when the film was released but was made a crime in 2010. The provision that made it illegal is often known as the Eddie Murphy Rule.

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Header image source: Joseph Sohm (Shutterstock)

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