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Difficulty: MediumTypes of Orders and Order Execution Strategies

An investor holding 500 shares of Acorn Corp. stock (currently trading at 52pershare)entersanorderwithinstructions:"Sell500AcornCorp.Stop47,Limit46GTC."Beforethemarketopensthenextmorning,negativecorporatenewsisreleased,causingthestocktoopenandtradeimmediatelyat52 per share) enters an order with instructions: "Sell 500 Acorn Corp. Stop 47, Limit 46 GTC." Before the market opens the next morning, negative corporate news is released, causing the stock to open and trade immediately at 43 per share. Which of the following best describes the status and execution of the investor's order at the market open?

  1. The order is triggered because the market price dropped to or below 47,butitisnotexecutedbecausethemarketpriceiscurrentlybelowthelimitpriceof47, but it is not executed because the market price is currently below the limit price of 46.Answer
  2. B
    The order is triggered and immediately executes at $43 per share as a market order.
  3. C
    The order is automatically canceled by the exchange because the opening price gapped below both the stop and limit prices.
  4. D
    The order is not triggered because the stock opened below the limit price rather than touching the stop price first.

Answer

The order is triggered because the market price dropped to or below 47,butitisnotexecutedbecausethemarketpriceiscurrentlybelowthelimitpriceof47, but it is not executed because the market price is currently below the limit price of 46.
A Sell Stop-Limit order has two distinct phases. First, the trigger condition is met when the stock trades at or below the stop price (47).Becausethestockopenedat47). Because the stock opened at 43, the trigger condition is satisfied immediately. Second, upon activation, the order becomes a limit order to sell at 46orbetter.Becausethecurrentmarketpriceof46 or better. Because the current market price of 43 is below 46,thebrokercannotexecutethetradeuntilthemarketpricerecoverstoatleast46, the broker cannot execute the trade until the market price recovers to at least 46.

Step-by-Step Solution

1
Evaluate the trigger condition for the sell stop-limit order.
The stop price is 47.Thestockopensat47. The stock opens at 43, which is at or below $47.
A sell stop order activates whenever a trade occurs at or below the specified stop price.
2
Determine the order's state after activation.
The order converts into a Sell Limit order at $46.
A stop-limit order becomes a limit order at the limit price once triggered.
3
Check if the limit order execution requirement is met at the current market price.
The current market price is 43,whichislowerthanthelimitpriceof43, which is lower than the limit price of 46. The order cannot be executed.
A sell limit order requires execution at the limit price (46)orhigher.Sellingat46) or higher. Selling at 43 would violate the limit restriction.

Key Concept

Stop-Limit Order Activation and Execution Mechanics
Estimated Time:1m 15s
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Topics

Types of Orders and Order Execution Strategies