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Difficulty: HardTypes of Orders and Order Execution Strategies

An investor holding 500 shares of Acme Corporation enters a Good-Til-Canceled (GTC) Sell Stop-Limit order at 45Stop,45 Stop, 44.50 Limit when the stock is trading at 48.Overnight,negativenewsisreleased,andAcmestockopensthenexttradingdayat48. Overnight, negative news is released, and Acme stock opens the next trading day at 43.50. How will this order be processed upon the market open?

  1. A
    The order triggers at 43.50andimmediatelyexecutesasamarketorderattheopeningpriceof43.50 and immediately executes as a market order at the opening price of 43.50.
  2. The order triggers at 43.50andbecomesanunexecutedlimitordertosellat43.50 and becomes an unexecuted limit order to sell at 44.50 or better.Answer
  3. C
    The order is automatically cancelled because the opening market price gapped below both the stop price and the limit price.
  4. D
    The executing broker-dealer is obligated to fill the customer's order from its own inventory at the $45.00 stop price acting as a principal dealer.

Answer

The order triggers at 43.50andbecomesanunexecutedlimitordertosellat43.50 and becomes an unexecuted limit order to sell at 44.50 or better.
When a security opens at 43.50,atradehasoccurredatorbelowthestoppriceof43.50, a trade has occurred at or below the stop price of 45.00, which activates the Sell Stop-Limit order. Upon activation, the order becomes a limit order to sell at 44.50orhigher.Becausetheprevailingmarketpriceof44.50 or higher. Because the prevailing market price of 43.50 is lower than the required minimum execution price of 44.50,theordercannotbefilledandsitsontheorderbookasanactivelimitorderwaitingforthestockpricetoriseto44.50, the order cannot be filled and sits on the order book as an active limit order waiting for the stock price to rise to 44.50 or above.

Step-by-Step Solution

1
Determine if the stop price trigger condition has been satisfied.
The opening price of 43.50islessthanorequaltothestoppriceof43.50 is less than or equal to the stop price of 45.00, so the stop condition is triggered.
A sell stop order activates whenever a transaction occurs at or below the specified stop price.
2
Identify the resulting order type once triggered.
The order converts into a limit order to sell at $44.50 or higher.
Because this is a stop-limit order rather than a plain stop order, activation creates a limit order with the specified price boundary rather than a market order.
3
Evaluate execution eligibility at the current market price of $43.50.
The order cannot execute because the market price of 43.50isbelowtherequiredlimitpriceof43.50 is below the required limit price of 44.50.
A sell limit order can only be executed at the limit price ($44.50) or a higher/better price.

Key Concept

Stop-Limit Order Trigger vs Execution Mechanics under Gapping Market Conditions
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Topics

Types of Orders and Order Execution Strategies