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Difficulty: MediumTypes of Orders and Order Execution Strategies

An equity investor is tracking Apex Semiconductor stock, which currently trades at 55pershare.Technicalanalysisleadstheinvestortobelievethatifthemarketpricerisesto55 per share. Technical analysis leads the investor to believe that if the market price rises to 60, it will signal a bullish breakout. The investor wants to buy 200 shares only if the stock price reaches 60,butwantstoensurethatthepurchasepricedoesnotexceed60, but wants to ensure that the purchase price does not exceed 62 per share. Which of the following order types and parameter combinations should the investor enter to fulfill these instructions?

  1. A Buy Stop-Limit order with a stop price of 60andalimitpriceof60 and a limit price of 62Answer
  2. B
    A Buy Limit order with a limit price of $60
  3. C
    A Buy Stop order with a stop price of $62
  4. D
    A Sell Stop-Limit order with a stop price of 60andalimitpriceof60 and a limit price of 62

Answer

A Buy Stop-Limit order with a stop price of 60andalimitpriceof60 and a limit price of 62
The correct choice is the Buy Stop-Limit order with a stop price of 60andalimitpriceof60 and a limit price of 62. A Buy Stop order is placed above the current market price (55)totriggerwhenthemarketreachesaspecifiedresistancelevel(55) to trigger when the market reaches a specified resistance level ( 60). Specifying a limit price of 62ensuresthatoncetheorderisactivatedat62 ensures that once the order is activated at 60, it will only execute at $62 or better (lower), protecting the investor from paying an unacceptable price during a rapid price surge.

Step-by-Step Solution

1
Identify the placement direction relative to the current market price.
The current market price is 55,andtheinvestorwantstopurchasesharesonlyafterthepricerisesto55, and the investor wants to purchase shares only after the price rises to 60. Because the target price is above the current market price, a Stop order is required to hold the order until the market reaches $60.
Limit orders placed to buy above current market prices execute immediately, whereas Stop orders remain dormant until activated by a trade or quote at or above the stop price.
2
Determine the execution protection mechanism.
The investor wants to cap the maximum price paid at 62.Addingalimitinstructionof62. Adding a limit instruction of 62 ensures that once activated at 60,theorderconvertstoaBuyLimitorderexecutableat60, the order converts to a Buy Limit order executable at 62 or lower.
A standard Buy Stop order converts into a market order upon activation, which could execute at any price above $60 in a volatile or gapping market.
3
Combine the trigger condition and execution limit into the correct order qualifier.
The combined order is a Buy Stop-Limit order with a stop price of 60andalimitpriceof60 and a limit price of 62.
This specific order type fulfills both criteria: triggering at 60andcappingexecutionat60 and capping execution at 62.

Key Concept

Buy Stop-Limit Orders and Order Execution Rules
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Topics

Types of Orders and Order Execution Strategies