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Difficulty: MediumTypes of Orders and Order Execution Strategies

An investor holding shares of Beacon Energy stock, currently trading at 45pershare,placesaSellStoporderat45 per share, places a Sell Stop order at 40 to limit potential downside loss. The following morning, after an unexpected negative regulatory update overnight, the stock gaps down and opens at 36pershare,withimmediatesubsequentmarkettradesoccurringat36 per share, with immediate subsequent market trades occurring at 35.80 and $35.90. At which of the following prices will the investor's order execute?

  1. A
    $40.00, because a stop order guarantees execution at the specified stop price once activated.
  2. 36.00,becausereachingorfallingbelow36.00, because reaching or falling below 40.00 triggers the order into a market order, executing at the next available market price.Answer
  3. C
    The order will not execute because the opening price bypassed the exact $40.00 trigger threshold.
  4. D
    $40.00, because the broker-dealer must act as a principal dealer and absorb the price gap from inventory.

Answer

The order executes at 36.00,becausefallingtoorbelow36.00, because falling to or below 40.00 triggers the sell stop order into a market order that executes at the next available market price.
A Sell Stop order at 40istriggeredwheneveramarkettransactionoccursatorbelow40 is triggered whenever a market transaction occurs at or below 40. When Beacon Energy gaps down overnight and opens at 36,thetriggerconditionismetimmediatelyontheopeningtrade.Oncetriggered,thestoporderinstantlyturnsintoamarketordertosell,executingatthebestavailablecurrentprice,whichis36, the trigger condition is met immediately on the opening trade. Once triggered, the stop order instantly turns into a market order to sell, executing at the best available current price, which is 36. Stop orders provide activation triggers but do not guarantee a specific execution price.

Step-by-Step Solution

1
Identify the trigger criteria for a Sell Stop order
A Sell Stop order set at 40.00isactivatedwhenatransactiontakesplaceatorbelow40.00 is activated when a transaction takes place at or below 40.00.
Understanding when a stop order becomes active is necessary to determine order status.
2
Evaluate the market opening price against the trigger criteria
The opening price of 36.00isbelow36.00 is below 40.00, which instantly activates the stop order on the market open.
Overnight market gaps trigger stop orders as soon as the first printed trade satisfies the trigger condition.
3
Determine the execution price of the activated market order
Upon activation, the order becomes a market order to sell, which executes immediately at the market price of $36.00.
A market order ensures execution speed at prevailing market prices but offers no price protection.

Key Concept

Sell Stop Order Activation and Execution Mechanics
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Topics

Types of Orders and Order Execution Strategies