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Difficulty: HardTypes of Orders and Order Execution Strategies

An investor holding a short position in XYZ stock, currently trading at 52.00pershare,placesaGood−Til−Canceled(GTC)ordertobuy500sharesofXYZatStop55.00tocappotentiallosses.Beforethemarketopeningthefollowingmorning,unexpectedpositiveearningsnewscausesXYZstocktogapupandopenat52.00 per share, places a Good-Til-Canceled (GTC) order to buy 500 shares of XYZ at Stop 55.00 to cap potential losses. Before the market opening the following morning, unexpected positive earnings news causes XYZ stock to gap up and open at 58.25. Which of the following best describes the execution and handling of this order?

  1. The order triggers immediately at the market opening price of 58.25andconvertsintoamarketorder,executingatthenextavailablemarketpricearound58.25 and converts into a market order, executing at the next available market price around 58.25.Answer
  2. B
    The order triggers when the stock crosses 55.00,butconvertsintoalimitorderrequiringanexecutionpriceof55.00, but converts into a limit order requiring an execution price of 55.00 or lower.
  3. C
    The executing broker-dealer acts as a principal to guarantee execution at the specified stop price of 55.00,absorbingthepriceslippageof55.00, absorbing the price slippage of 3.25 per share.
  4. D
    The order is automatically canceled by the exchange because the opening gap price exceeds the designated stop price by more than 5%.

Answer

The order triggers immediately at the market opening price of 58.25andconvertsintoamarketorder,executingatthenextavailablemarketpricearound58.25 and converts into a market order, executing at the next available market price around 58.25.
A buy stop order becomes a market order immediately when a trade occurs at or above the stop price. Because the stock opened at 58.25(higherthanthe58.25 (higher than the 55.00 stop price), the order was activated instantly at the open and filled as a market order at the available market price around $58.25.

Step-by-Step Solution

1
Identify the type of order and its activation condition.
The order is a Buy Stop at 55.00.Abuystoporderisactivated(elected)whenthestocktradesatorabovethespecifiedstopprice(55.00. A buy stop order is activated (elected) when the stock trades at or above the specified stop price ( 55.00 or higher).
Buy stop orders are entered above the current market price, typically to protect a short position against rising prices.
2
Evaluate the market condition at the open.
The stock opens at 58.25,whichisstrictlygreaterthanthe58.25, which is strictly greater than the 55.00 stop price threshold.
A price gap above the stop price instantly satisfies the trigger condition at the market opening bell.
3
Determine the order execution behavior upon activation.
Once triggered, a stop order becomes an active market order and executes at the best available price in the market.
Market orders prioritize speed and completion of execution over price, so the order will fill at or near the opening price of $58.25.

Key Concept

Buy Stop Order Activation and Market Order Conversion
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Topics

Types of Orders and Order Execution Strategies