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Question

Difficulty: EasyTypes of Orders and Order Execution Strategies

An investor sells short 100 shares of XYZ stock at 50pershareandentersaBuyStoporderat50 per share and enters a Buy Stop order at 55 to limit potential losses. If XYZ stock rises and trades at $55, which of the following best describes the status and execution of this order?

  1. The order is triggered and converts into a market order to buy, executing at the next available market price.Answer
  2. B
    The order is executed with a guarantee of receiving $55.00 or a lower price as a limit order.
  3. C
    The order can only be executed if the firm fills the customer's trade in a dealer capacity from its own inventory.
  4. D
    The order is automatically canceled because stop orders cannot be placed to hedge short positions.

Answer

The order is triggered and converts into a market order to buy, executing at the next available market price.
A buy stop order is placed above the current market price. When the market price reaches or rises past the stop price ($55), the order is triggered (elected) and immediately converts into a market order to buy at the next available market price.

Step-by-Step Solution

1
Identify the order type and purpose
The order is a Buy Stop order at $55 placed to limit losses on a short stock position.
Buy stop orders are entered above the current market price to cap loss on short positions or capture upside momentum.
2
Determine the effect of reaching the stop price
When XYZ trades at $55, the stop condition is satisfied and the order is triggered.
A trade or bid/ask quote at or above the stop price activates (elects) the buy stop order.
3
Evaluate execution behavior post-activation
The activated order becomes a market order and fills at the next available market price.
Once triggered, a stop order transforms into a market order, ensuring execution but not a specific price.

Key Concept

Buy Stop Order Activation Mechanics
Estimated Time:45s
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Topics

Types of Orders and Order Execution Strategies