Trading Places and Short Selling

Billy Ray Valentine learns about commodities trading here and then he puts his knowledge to good use with a little short selling here.

How did it work?

Explanation of climactic scene [from Wikipedia see here]

With the authentic orange crop report indicating a good harvest of fresh oranges, frozen concentrated orange juice (FCOJ) would be less important to food producers and so would be likely to drop in price once traders heard the news. However, by way of a fraudulent report, the Duke brothers are led to believe that the orange harvest would be less successful, necessitating greater demand for stockpiled FCOJ in orange products in the coming year, thereby driving the price up.

By capitalizing on this knowledge (and the Duke brothers' missteps) the protagonists are able to profit by manipulating the futures market as follows:

Unlike a conventional stock transaction, futures contracts can be sold even when the seller does not yet own any of the commodity. A contract to sell, for example, 15,000 pounds of FCOJ in April at $1.42 per pound, merely indicates the seller's obligation to deliver and the buyer's obligation to purchase the product at the specified price and time. It does not matter how or where the seller gets the product, as long as, one way or another, he is able to deliver it at that price at that time, even if it results in a sale at a loss to him.

In this case, Winthorpe and Valentine first sell FCOJ futures at $1.42 per pound, a price inflated by the Dukes themselves. (The Duke Brothers' buying leads other traders to believe that the Dukes are trying to corner the market, causing a buying frenzy.) Then, when the price falls — first as a result of Winthorpe and Valentine's eager selling, then to a much greater degree upon the release of the real crop report indicating a good harvest — Winthorpe and Valentine buy futures for prices between $.46 and $.29 per pound.

Thus, for every futures contract they had previously sold at about $1.42, they buy another back (for resale to those who bought the expensive contracts from them previously) for only $.46 to $.29, resulting in a profit of $.96 to $1.13 per pound. In actual markets, price limits – "limit up" and "limit down" – protect the clearinghouse from defaults and would preclude such a drastic price jump.

Though it is not stated in the movie exactly how much they make, if they invested roughly $500,000 from a combination of Winthorpe/Valentine's investment, the Dukes' money from buying the fake report from Billy Ray posing as Clarence Beeks, and Coleman's and Ophelia's savings, they would have turned it into over $10 million.

It is strongly implied that they purchased additional futures on margin and made dozens (or hundreds) of millions more, since a lesser amount would not bankrupt the Dukes. Likely, the bribe money for Beeks that Valentine received was enough to leverage such a massive loss from the Dukes.

At the same time that Winthorpe/Valentine sell their futures contracts, the Duke brothers are rapidly purchasing them, even at high prices, because they incorrectly expect that the crop report (falsely suggesting a greater need for stockpiled orange juice) will create a demand at even higher prices, securing them a profit.

When it turns out that the leaked report they were given was fraudulent and the true report is revealed, the price begins to plummet before they are able to sell off their contracts. This leaves them with an obligation to buy millions of pounds of FCOJ at a price more than a dollar per pound higher than they can sell them for, bankrupting them. The legality of Winthorpe/Valentine's actions can be questioned but commodities markets do not have insider trading laws as in the stock markets.