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Difficulty: HardTypes of Orders and Order Execution Strategies

An investor holding a long position in ABC Corporation stock (currently trading at 45pershare)entersanorderspecifiedas:′Sell1,000ABCat45 per share) enters an order specified as: 'Sell 1,000 ABC at 40 Stop, 38Limit,GTC.′Overnight,negativecorporateearningsareannounced,causingABCstocktoopenthefollowingmorningat38 Limit, GTC.' Overnight, negative corporate earnings are announced, causing ABC stock to open the following morning at 37 per share. Throughout the entire trading session, the stock trades in a narrow range between 36.50and36.50 and 37.50. What is the status of the investor's order at the end of the trading day?

  1. The order was activated upon the opening price of 37,butitremainsunexecutedbecausethemarketpriceneverreachedthelimitpriceof37, but it remains unexecuted because the market price never reached the limit price of 38.Answer
  2. B
    The order was activated and immediately executed at the opening price of $37 because activating a stop order guarantees immediate execution at the prevailing market price.
  3. C
    The order was never activated because the stock gapped below the stop price of 40withouttradingexactlyat40 without trading exactly at 40.00 during regular market hours.
  4. D
    The executing broker-dealer was required to buy the stock into its own inventory at $38.00 as a principal to fulfill its regulatory duty of execution.

Answer

The order was activated upon the opening price of 37,butitremainsunexecutedbecausethemarketpriceneverreachedthelimitpriceof37, but it remains unexecuted because the market price never reached the limit price of 38.
A sell stop-limit order requires two distinct events: first, the stop price must be triggered by a transaction at or below 40.00;second,theresultinglimitordermustbeexecutedatorabove40.00; second, the resulting limit order must be executed at or above 38.00. The opening price of 37.00triggersthestopinstruction,convertingtheorderintoaselllimitorderat37.00 triggers the stop instruction, converting the order into a sell limit order at 38.00. Because market prices throughout the day did not reach $38.00, the limit condition was not satisfied, and the order remained active but unexecuted.

Step-by-Step Solution

1
Determine if the activation condition (stop trigger) was met.
A sell stop order at 40triggerswhenthemarketpricetradesatorbelow40 triggers when the market price trades at or below 40. The opening price of 37isbelow37 is below 40, so the order is activated.
Stop prices act as thresholds that trigger the order into an active state upon being reached or passed.
2
Identify the resulting order type after activation.
Because this is a stop-limit order (40Stop,40 Stop, 38 Limit), once activated, it converts into a Limit Order to sell at $38 or higher.
Stop-limit orders convert into limit orders upon trigger, not market orders.
3
Evaluate execution eligibility against prevailing market prices.
The market traded between 36.50and36.50 and 37.50 all day. A sell limit at 38requiresamarketpriceof38 requires a market price of 38 or higher to execute. Therefore, the order remains unfilled.
Limit orders mandate that execution occurs only at the limit price or better.

Key Concept

Stop-Limit Order Triggering and Execution Mechanics
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Topics

Types of Orders and Order Execution Strategies