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Difficulty: MediumTypes of Orders and Order Execution Strategies

An investor holding a long position in stock currently trading at 85persharewantstoguardagainstapricedecline.However,theinvestorexplicitlyinstructstherepresentativethatifthestockfalls,theydonotwishtosellforanypricelowerthan85 per share wants to guard against a price decline. However, the investor explicitly instructs the representative that if the stock falls, they do not wish to sell for any price lower than 80 per share. To satisfy these instructions, the representative places a Sell Stop-Limit order at 80.Ifthestockunexpectedlygapsdownatthemarketopenandtradesat80. If the stock unexpectedly gaps down at the market open and trades at 76 per share, what is the immediate execution status of the order?

  1. A
    The order is triggered and immediately executed at the market price of $76 per share.
  2. The order is activated by the trade at 76andbecomesanactivelimitordertosellat76 and becomes an active limit order to sell at 80 or better, remaining unexecuted.Answer
  3. C
    The order is automatically cancelled because the opening market price bypassed the stop price.
  4. D
    The broker-dealer is obligated to buy the shares into inventory at $80 per share as a principal dealer to satisfy the customer limit.

Answer

The order is activated by the trade at 76andbecomesanactivelimitordertosellat76 and becomes an active limit order to sell at 80 or better, remaining unexecuted.
A sell stop-limit order requires two events: first, a trade at or below the stop price (80)triggerstheorder;second,onceactivated,theorderbecomesalimitordertosellatorabovethelimitprice(80) triggers the order; second, once activated, the order becomes a limit order to sell at or above the limit price ( 80). When the stock opens at 76,thetradeat76, the trade at 76 is at or below 80,whichtriggerstheorder.However,becauseitisnowalimitorderrequiringaminimumexecutionpriceof80, which triggers the order. However, because it is now a limit order requiring a minimum execution price of 80, it cannot execute at 76andremainsunexecutedontheorderbookuntilthemarketpricereaches76 and remains unexecuted on the order book until the market price reaches 80 or higher.

Step-by-Step Solution

1
Identify the trigger condition for a Sell Stop-Limit order at $80.
A sell stop order at 80istriggeredwhenatransactionoccursatorbelow80 is triggered when a transaction occurs at or below 80.
The market opening price of 76isbelow76 is below 80, so the stop requirement is satisfied.
2
Determine the order type after activation.
Once triggered, the order converts into a limit order to sell at $80 or higher.
A stop-limit order does not become a market order upon activation; it becomes a limit order bounded by the limit price.
3
Evaluate execution capability at the current market price of $76.
The order remains unexecuted on the order book.
A limit order to sell at 80orbettercannotexecutewhiletheprevailingmarketpriceis80 or better cannot execute while the prevailing market price is 76.

Key Concept

Stop-Limit Order Mechanics and Market Gaps
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Topics

Types of Orders and Order Execution Strategies