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Difficulty: MediumTypes of Orders and Order Execution Strategies

An investor who sold short 1,000 shares of a stock currently trading at 45pershareplacesaBuyStop50,Limit52ordertoprotectagainstupwardpricemovement.Followingtheorderentry,thestocktradesinthefollowingmarketsequence:45 per share places a Buy Stop 50, Limit 52 order to protect against upward price movement. Following the order entry, the stock trades in the following market sequence: 48.00, 49.50,49.50, 50.25, 52.50,52.50, 51.75. Which of the following statements correctly describes the activation and execution of this order?

  1. The order is activated when the stock trades at 50.25andsubsequentlyexecutesat50.25 and subsequently executes at 51.75.Answer
  2. B
    The order is activated at 50.25andimmediatelyexecutesat50.25 and immediately executes at 50.25 as a market order.
  3. C
    The order is activated at 50.25andexecutesat50.25 and executes at 52.50 because the price surpassed the limit price threshold.
  4. D
    The order executes at $49.50 prior to reaching the stop price in order to minimize prospective losses.

Answer

The order is activated when the stock trades at 50.25(atorabovethe50.25 (at or above the 50 stop price), transforming into a buy limit order at 52,whichthenexecuteswhenthepricedropsto52, which then executes when the price drops to 51.75 (at or below the $52 limit price).
A buy stop-limit order operates in two sequential stages. First, the stop price of 50actsasanactivationtrigger,whichoccurswhenthestocktradesat50 acts as an activation trigger, which occurs when the stock trades at 50.25 (at or above 50).Oncetriggered,theorderconvertsintoabuylimitorderat50). Once triggered, the order converts into a buy limit order at 52.00. A buy limit order can only be filled at the limit price of 52.00orlower.Whenthemarkettradesat52.00 or lower. When the market trades at 52.50, the order cannot execute because the price exceeds the maximum limit threshold. The order successfully fills when the market trades at 51.75,whichsatisfiestherequirementofbeingatorbelow51.75, which satisfies the requirement of being at or below 52.00.

Step-by-Step Solution

1
Determine when the stop trigger condition is satisfied.
A buy stop order triggers when a trade takes place at or above the stop price (50).Thetransactionat50). The transaction at 50.25 triggers the order.
Buy stop orders require a trade at or above the stop price to become active.
2
Identify the active order type after triggering.
Upon activation, the order becomes a Buy Limit order at $52.00.
A stop-limit order converts into a limit order at the specified limit price once triggered.
3
Evaluate subsequent market prices against the limit price restriction.
The trade at 52.50exceedsthemaximumlimitpriceof52.50 exceeds the maximum limit price of 52.00 and cannot execute. The next trade at 51.75isatorbelow51.75 is at or below 52.00 and executes the order.
Buy limit orders can only be executed at the limit price or lower.

Key Concept

Buy Stop-Limit Order Mechanics
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Topics

Types of Orders and Order Execution Strategies