Every time I watch the movie Trading Places, I have to search the internet for an explanation of the climactic commodities trading scene. It usually takes me about 20 minutes to (re-)understand it, then another 10 minutes to explain it to my wife. Although there are plenty of great answers available, none of them really “speak” to me; so I decided to write my own. The goal for me is to be able to (re-)read my explanation and understand it enough to explain to someone else in less than 5 minutes.
This scene is tricky for non-stockbrokers to understand because you need to know a lot about trading, and you also need to know some important plot details. Rather than continue to look everything up on the internet each time, I figured I’d write this blog entry instead.
The Crop Reports, real and fake. In the movie, the Dukes plan to cheat. But the “good guys” (Valentine and Winthrope) foil them by replacing their stolen, ill-gotten crop report with a fake. This allows the “good guys” to win. To understand the reverse-swindle, you must understand the crop reports (real and fake) and the market repercussions of each:
|Report (FAKE)||Report (REAL)|
|Harvest (i.e. # oranges)||LOW||HIGH|
The (Duke’s) agent wants to own as many contracts as possible before the crop report is revealed, since (he thinks) once it is, the price will go up and he can sell at a profit. Trading begins with a price of 102 cents per pound, which translates into $15,300 per contract. Once everyone sees that the Dukes’ agent is trying to corner the market, they all want a piece of it, forcing the price up since more people are buying than selling.
I’ll repeat that last part: when trading opens before the true crop report is revealed more people are buying than selling.
The “good guys” know the truth i.e. that the current buying trend is based on the Duke’s actions which are based on false information. That brings us to another important point: the “good guys” realize an opportunity to “sell short”. Or as Chris Carter puts it:
They are betting they will be able to buy the contracts later at a lower price so they come out making money but not holding any contracts at the end of trading.
Ding! Ding! Ding! So after all this, here’s what’s really happening: the “good guys” successfully carry out a short sale, with the help of the “bad guys” who are trying to corner the market but acting on false information. Or as Chris Carter puts it, after the real crop report is published:
They (the “good guys”) need to buy–a lot–to zero their position, and the crowd is more than willing to oblige.
Finally, the “good guys” are able to buy enough to contracts to fulfill the number of “short” sales they made. And they are able to purchase them for much less then they made the “short” sales for. Profit!
Does it make sense now? If not, let me know in the comments.