Examkin

Question

Difficulty: Very hardTypes of Orders and Order Execution Strategies

An investor holding a short position in XYZ stock, currently trading at 52.00pershare,entersa′BuyStop55,Limit57′ordertomanageupsiderisk.Priortothemarketopenthenextmorning,unexpectedpositivecorporatenewscausesthestocktoopensignificantlyhigherat52.00 per share, enters a 'Buy Stop 55, Limit 57' order to manage upside risk. Prior to the market open the next morning, unexpected positive corporate news causes the stock to open significantly higher at 58.00 per share. Following the open, the stock trades sequentially at 58.00,58.00, 57.50, 56.50,56.50, 57.10, and $59.00. Assuming no other orders interfere, how will this order be executed?

  1. The order triggers at the market open of 58.00andexecuteswhenthepricedeclinesto58.00 and executes when the price declines to 56.50.Answer
  2. B
    The order executes immediately at the market opening price of $58.00 upon activation.
  3. C
    The order is never triggered because the market opening price of 58.00exceededthelimitpriceof58.00 exceeded the limit price of 57.00.
  4. D
    The order triggers at 58.00andexecutesatexactlythespecifiedlimitpriceof58.00 and executes at exactly the specified limit price of 57.00.

Answer

The order is triggered at the market open of 58.00andsubsequentlyexecuteswhenthestockpricedropsto58.00 and subsequently executes when the stock price drops to 56.50.
A 'Buy Stop 55, Limit 57' order functions in two distinct stages. First, the trigger mechanism is activated when a transaction occurs at or above 55.00.Theopeningtradeat55.00. The opening trade at 58.00 satisfies this condition, triggering the order immediately at market open. Second, upon activation, the order turns into a Buy Limit order at 57.00,whichrequiresanexecutionpriceof57.00, which requires an execution price of 57.00 or lower ('better'). Following the open (58.00),thepricedropsto58.00), the price drops to 57.50 (still too high), then to 56.50.Because56.50. Because 56.50 is lower than the limit price of 57.00,thebuyorderexecutesat57.00, the buy order executes at 56.50.

Step-by-Step Solution

1
Determine order trigger activation
The order triggers at $58.00.
A Buy Stop order triggers when a transaction occurs at or above the stop price (55.00).Themarketopenpriceof55.00). The market open price of 58.00 is greater than $55.00, so the stop price is activated immediately at the open.
2
Convert the order to its active state
The order becomes an active Buy Limit order at $57.00.
Once the stop price is satisfied, a stop-limit order becomes a standard limit order governed by the limit price ($57.00).
3
Evaluate subsequent market prints against the limit price
The order executes at $56.50.
A buy limit order mandates execution at the limit price (57.00)orbetter(lower).Pricesof57.00) or better (lower). Prices of 58.00 and 57.50arehigherthan57.50 are higher than 57.00 and cannot execute. The print of 56.50satisfiesthe′limit56.50 satisfies the 'limit 57.00 or better' condition, resulting in execution at $56.50.

Key Concept

Two-phase execution dynamics of Stop-Limit orders and limit order price improvement rules
Rate this question

Topics

Types of Orders and Order Execution Strategies