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Difficulty: Very hardTypes of Orders and Order Execution Strategies

An investor holding 1,000 shares of XYZ stock currently trading at 48.00placesaGood−Til−Canceled(GTC)sellstop−limitorderat48.00 places a Good-Til-Canceled (GTC) sell stop-limit order at 44.00 stop, 43.50limit.Overnight,severenegativemarketnewsisannounced.Atthemarketopenthenexttradingday,XYZstockgapsdownandexecutesitsopeningtransactionat43.50 limit. Overnight, severe negative market news is announced. At the market open the next trading day, XYZ stock gaps down and executes its opening transaction at 41.00 per share. Later during the trading session, the stock price rallies back up, trading between 41.00and41.00 and 44.20 before closing at $43.80. Assuming sufficient liquidity exists at all traded prices, how is this investor's order handled during the trading day?

  1. The order is triggered at the opening price of 41.00andbecomesaselllimitorderat41.00 and becomes a sell limit order at 43.50, which is subsequently filled at $43.50 or better when the stock rallies during the session.Answer
  2. B
    The order converts to a market order upon opening at 41.00andisimmediatelyexecutedattheopeningpriceof41.00 and is immediately executed at the opening price of 41.00.
  3. C
    The order is never elected because the stock gapped below 44.00withoutprintinganexacttradepriceof44.00 without printing an exact trade price of 44.00.
  4. D
    The order is automatically canceled at the opening bell because opening below the limit price violates market maker order handling rules.

Answer

The order is elected at the opening trade of 41.00,convertingintoaselllimitorderat41.00, converting into a sell limit order at 43.50, which is then filled at $43.50 or higher as the stock price rallies later in the session.
A sell stop-limit order operates in two distinct stages: (1) Activation/Election: When the stock trades at or below the stop price of 44.00,theorderisactivated.Theopeningpriceof44.00, the order is activated. The opening price of 41.00 satisfies this condition immediately. (2) Execution: Upon election, the order becomes a live sell limit order at 43.50.Aselllimitordercanonlybeexecutedat43.50. A sell limit order can only be executed at 43.50 or higher. Because the stock subsequently rallies during the day up to 44.20,marketliquidityatorabove44.20, market liquidity at or above 43.50 allows the order to be executed at or above the limit price.

Step-by-Step Solution

1
Determine order trigger (election) condition.
A sell stop at 44.00iselectedwhenatradeoccursatorbelow44.00 is elected when a trade occurs at or below 44.00.
The market opens at 41.00,whichisbelow41.00, which is below 44.00, so the stop trigger condition is met at the opening print.
2
Identify the resulting order type after election.
The order transforms into a Sell Limit order at $43.50.
Because it is a stop-limit order (not a market stop order), election converts it into a limit order with a minimum acceptable execution price of $43.50.
3
Evaluate execution capability during the trading session.
The stock trades up to a high of 44.20,crossingthelimitpriceof44.20, crossing the limit price of 43.50.
Since market prices reach and exceed 43.50,theselllimitorderisfilledat43.50, the sell limit order is filled at 43.50 or better.

Key Concept

Mechanics of Sell Stop-Limit Orders during Market Gaps and Subsequent Price Recovery
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Topics

Types of Orders and Order Execution Strategies