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Difficulty: Very hardTypes of Orders and Order Execution Strategies

An investor holding a long position in ABC stock enters a 'Sell Stop 50, Limit 48' order when ABC is trading at 55pershare.Overnight,unexpectednegativeearningsnewsisreleased,causingABCstocktogapdownandopenthenexttradingsessionat55 per share. Overnight, unexpected negative earnings news is released, causing ABC stock to gap down and open the next trading session at 44 per share. Following the open, consecutive market trades occur at 43.50,43.50, 46.00, 48.50,and48.50, and 49.00. Which of the following statements regarding the activation and execution of this order are correct?

  1. The order is activated at the market open when ABC trades at 44.00andimmediatelybecomesanactivelimitordertosellat44.00 and immediately becomes an active limit order to sell at 48.00 or higher.Answer
  2. B
    The order executes immediately at the market opening price of $44.00 because a triggered stop order converts into a market order that guarantees execution at the next available price.
  3. The order cannot execute at 44.00,44.00, 43.50, or 46.00,butbecomeseligibleforexecutiononcethemarketpricereaches46.00, but becomes eligible for execution once the market price reaches 48.50.Answer
  4. D
    The order fails to trigger at the market open because the opening price of 44.00bypassedtheexactstoppriceof44.00 bypassed the exact stop price of 50.00 without hitting it directly.

Answer

The correct statements are that the order activates at the market open price of 44.00tobecomeaselllimitorderat44.00 to become a sell limit order at 48.00 or higher, and that it cannot execute at prices below 48.00(suchas48.00 (such as 44.00, 43.50,or43.50, or 46.00) but becomes eligible once the price rises to $48.50.
A sell stop-limit order has two distinct phases: activation (stop trigger) and execution (limit rule). The stop price of 50.00meanstheorderactivateswhenABCtradesatorbelow50.00 means the order activates when ABC trades at or below 50.00. Because the stock opens at 44.00(whichislessthan44.00 (which is less than 50.00), the stop is triggered immediately at the open, transforming the order into a limit order to sell at 48.00orhigher.Asaselllimitorder,executioncanonlyoccurat48.00 or higher. As a sell limit order, execution can only occur at 48.00 or above. Consequently, the trades at 44.00,44.00, 43.50, and 46.00areineligible,whereasthetradeat46.00 are ineligible, whereas the trade at 48.50 meets the limit condition and allows execution.

Step-by-Step Solution

1
Determine the trigger condition for a Sell Stop 50, Limit 48 order.
A sell stop order triggers when a transaction occurs at or below the stop price of $50.00.
Understanding the activation rule for sell stop orders.
2
Evaluate the effect of the opening gap down trade at $44.00.
Since 44.00isbelow44.00 is below 50.00, the order is triggered at the market open and converts into a Sell Limit order at $48.00.
A price gap below the stop price activates the order immediately; exact price touch is not required.
3
Analyze the execution parameters of the activated Sell Limit 48 order against subsequent trades.
A sell limit order requires an execution price of 48.00orhigher.Tradesat48.00 or higher. Trades at 44.00, 43.50,and43.50, and 46.00 cannot execute the order. The trade at 48.50satisfiesthelimitcondition(48.50 satisfies the limit condition ( 48.50 >= $48.00).
Limit orders guarantee price priority (limit price or better) but do not guarantee execution if the market does not meet the specified price.

Key Concept

Mechanics of Stop-Limit Orders and Execution Rules on Market Gaps
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Topics

Types of Orders and Order Execution Strategies