Trading Places more fun than fact-based

Advisor versus Film: Trading Places

Film: Trading Places (1983)

Expert: Murray Hodgins, commodity and futures advisor and derivatives portfolio manager at PI Financial Corp.

Accuracy Rating: 5/10

Trading Places (1983) offers a comedic perspective on commodities trading, but its main caper wouldn’t play out the same way today.

Dan Aykroyd stars as elitist commodities broker Louis Winthorpe III, who works for a trading house owned by the enormously wealthy Duke brothers. Eddie Murphy plays Billy Ray Valentine, a hustler who gets arrested for stealing Winthorpe’s briefcase.

The Duke brothers bet each other $1 on whether Valentine could become a successful commodities broker under better circumstances, and whether snobby Winthorpe would resort to criminal behaviour should he lose his wealth. They fire Winthorpe and he becomes homeless while they give Valentine Winthorpe’s old house, salary and job.

At first, Winthorpe becomes a drunk and Valentine a pompous aristocrat. But after discovering the brothers’ bet, Winthorpe and Valentine team up to destroy the Dukes by bankrupting their firm by shorting orange juice contracts.

Along the way, Valentine and Winthorpe find themselves in many comedic misadventures, but the plot centres on commodities trading. So how accurate is it?

Valentine’s fast success

As soon as Valentine and Winthorpe trade lives, Valentine goes to work at the Dukes’ firm.

Murray Hodgins, a commodities and futures advisor and portfolio manager at PI Financial, says Valentine couldn’t have become an actual broker that quickly because of the intense coursework and training necessary.

“They never show that in the movie. It’s a series of writing your futures and other exams that give you the license required to deal in the marketplace,” he says, adding that we don’t see Valentine taking clients’ orders, so it’s likely the Dukes are employing him as an analyst or consultant instead.

The Dukes explain commodities

One of the most memorable scenes in Trading Places is when the Duke brothers explain commodities trading to Valentine. They show him plates of orange juice, coffee and gold, and explain that clients speculate on whether commodities such as those will increase or decrease in price. The clients then place orders with their firm. Regardless of the outcome of the contract, the Dukes tell Valentine, the broker receives a commission.

Hodgins says this is an accurate explanation of commodities speculation, but it ignores commodities hedging.

“In the movie, it was all speculation. Either you’re betting the price will go up or down. People place orders based on those suspicions. In its basic simple form — a speculator — that’s right.”

Speculators, Hodgins explains, never make or take delivery of the commodity; their goal is to short the contract and buy it back it for profit prior to the date of delivery.

Here’s how it works: Joe, a speculator, doesn’t own frozen concentrated orange juice, but he expects the price of the juice to fall. Joe enters into a futures contract through the commodity futures exchange to sell orange juice, deliverable sometime in the future at a specific price and date. But he doesn’t actually own the orange juice.

Assume the price of orange juice drops before the delivery date as Joe predicted. Joe will then purchase an equivalent number of contracts as he sold (short). Buying the contracts before the delivery date offsets his short sale position, removing his obligation to deliver the orange juice and leaving Joe with a cash profit: the difference of the higher sell (short) price, versus the lower buy price. If the price of orange juice had risen after he entered his short (sell), he would then buy the futures contracts back at a higher price, resulting in a loss.

The term “short” or “short sale” is only used when someone sells a contract before buying it to cover his position, as Joe did. Had Joe bought a futures contract first and then sold, that’s called a sale, not a short, Hodgins notes.

If this all sounds a bit complicated, listen to Dan Aykroyd explain it here.

The commodities caper

Toward the end of the movie, Winthorpe and Valentine travel to the New York commodities exchange to foil the Dukes’ plot to corner the frozen orange juice market. On the floor, the audience sees a busy trading floor, bustling with clerks on the phone receiving orders, running paper futures tickets to the pit and yelling out prices to the floor broker.

“That’s where the physical people matching up buy and sell orders traded,” Hodgins explains.

Hodgins says, “In 1983, it would have been very accurate. Nowadays, most commodities futures trade electronically through the Chicago Mercantile Exchange (CME). In the world about 95% of all trading takes place electronically.”

In fact, the CME plans to close most of its open outcry pits, like the ones in Trading Places, by summer 2015.

“The process is still the same, it’s just the way we execute the trade is different. Now we do it electronically, while in 1983, they were doing it manually through open outcry trading in the pit,” says Hodgins. Clients call their broker to place an order. The broker puts the order on the exchange electronically, then calls the client back to confirm it was placed.

The final scene

In the last act of the movie, Winthorpe and Valentine bankrupt the Dukes by providing them false information about the annual orange crop. The plan is based on getting early access to a crop report from U.S. Department of Agriculture.

At first glance, getting access to a government report before it’s released and acting on the information may seem like insider trading, but in 1983, it wasn’t actually illegal to use that information to trade commodities, reports Planet Money. The practice was only outlawed in 2010 with a U.S. law that’s referred to as the Eddie Murphy Rule, because of Trading Places.

In the film, Valentine and Winthorpe alter the report to make it seem like the orange crop had failed. The Duke brothers assume that scarcity will cause prices to rise, so they buy as many frozen orange juice contracts as possible to corner the market, no matter the price. Their purchases start a buying frenzy that drives the price of frozen orange juice contracts from $1.02 per pound to $1.42 per pound.

Then Valentine and Winthorpe start shorting because they know the price will fall once the real report showing a healthy crop is released.

When the price reaches $1.42, Valentine and Winthorpe start making deals entitling them to later sell the orange juice at that price. Other traders agree to those deals because they think the price will continue to rise.

When the real report is released, it says the orange crop will in fact be better than expected. The traders realize they bought overvalued orange juice and start selling. The price plummets to $0.29 per pound. The Dukes bought orange juice while the contracts cost much more, and were forced to sell as the price fell, meaning they lost millions. Valentine and Winthorpe can now buy OJ at $0.29 per pound and sell it to traders who promised to buy at $1.42. They’ll be rich.

Hodgins says this scene “would be something that couldn’t happen in real life. Today commodities have daily limits. Orange juice for example can only trade in one day 10 cents a pound up or down — but in the movie they moved it a dollar in an hour.”

However, Hodgins says it is possible to make the kind of money depicted in the final scene in the commodities market — just not necessarily in frozen orange juice contracts.

For example, speculators who shorted oil futures in fall 2014 would have made a healthy profit, he says.

“If you just shorted crude oil at $95 a barrel [four or five months ago], now it’s trading at about $45 a barrel. That difference between $95 to $45 is $50 a barrel,” he says. Since oil futures contracts are sold in units of 1,000 barrels, a speculator holding one contract would have made $50,000, minus the initial $5,000 deposit the brokerage firm requires to establish the short.

Accuracy

“The things that are accurate would be the speed in which you can execute the trades and how fast everything would go. But the actual facts of the movie [aren’t accurate],” says Hodgins.

“What’s not accurate about the movie is how they got their information from the USDA report, before it was made public, so easily, and then substitute it,” he says. “That just wouldn’t happen.”

But the movie, which was shot during trading hours at New York’s commodities exchange, does a good job of illustrating how commodities trading was done. “In that respect, the execution of how they traded orange juice contracts from 1983 was accurate. From today, not really: Billy Ray and Winthorpe would just log into a computer.

“I have to give the movie a five out of 10. But in no way does that reflect on the movie itself; what it does very well is show the fast pace of the futures market, and the movie is really fun.”