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Difficulty: MediumTypes of Orders and Order Execution Strategies

An investor holding shares of common stock currently trading at 58persharewantstoprotectagainstdownsiderisk.TheinvestorplacesaSellStoporderat58 per share wants to protect against downside risk. The investor places a Sell Stop order at 55. Overnight, significant negative news is released, causing the stock to open the next trading session at $50 per share. Which of the following best describes the execution of the investor's order?

  1. The order is triggered at the market open and executes as a market order at the next available price around $50 per share.Answer
  2. B
    The order executes at exactly $55 per share because the stop price guarantees the execution price once triggered.
  3. C
    The order converts to a limit order and remains unexecuted until the market price recovers to at least $55 per share.
  4. D
    The order is automatically canceled because the opening price bypassed the specified stop price.

Answer

The order is triggered at the market open and executes as a market order at the next available price around $50 per share.
A Sell Stop order is placed below the current market price and is activated once a transaction occurs at or below the stop price. When the stock opens at 50pershare,thestoppriceof50 per share, the stop price of 55 has been breached, immediately activating the order. Upon activation, the stop order turns into a market order, which mandates immediate execution at the next best available price. Because the market opened at 50,thetradewillexecutenear50, the trade will execute near 50 per share.

Step-by-Step Solution

1
Identify the order type and its trigger mechanism.
The investor placed a Sell Stop order at $55.
A Sell Stop order is activated (triggered) when the stock trades at or below the specified stop price of $55.
2
Determine if the activation condition was met at the market open.
The stock opened at 50,whichisbelowthestoppriceof50, which is below the stop price of 55.
Because 50islowerthan50 is lower than 55, the trigger condition is satisfied immediately upon the opening trade.
3
Determine the order type post-activation and the expected execution price.
The order becomes a market order and executes at the best available prevailing market price (~$50).
Once activated, a stop order becomes a market order without price guarantees, executing at the next available market price.

Key Concept

Sell Stop Order Activation and Market Order Execution Dynamics
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Topics

Types of Orders and Order Execution Strategies