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Difficulty: HardTypes of Orders and Order Execution Strategies

An investor holding a short position in 500 shares of Omega Tech stock enters a Good-Til-Canceled (GTC) Buy Stop-Limit order at 65.00Stop,65.00 Stop, 65.50 Limit when the stock is trading at 58.00.Afterthemarketcloses,thecompanyannouncesanunexpectedbreakthroughproduct.Thefollowingmorning,OmegaTechstockopenssignificantlyhigherat58.00. After the market closes, the company announces an unexpected breakthrough product. The following morning, Omega Tech stock opens significantly higher at 66.25 and prints the following sequential trades: 66.50,66.50, 65.40, 64.85,and64.85, and 65.60. Which of the following best describes the execution outcome of the investor's order?

  1. The order is triggered at the market open price of 66.25andexecutesat66.25 and executes at 65.40 when the market price drops to or below the $65.50 limit price.Answer
  2. B
    The order is triggered at the market open and immediately executes at $66.25 because a triggered stop order converts into an unrestricted market order.
  3. C
    The order is never triggered because the stock gapped up and opened above 65.00withouttradingattheexactstoppriceof65.00 without trading at the exact stop price of 65.00.
  4. D
    The broker-dealer automatically cancels the order at the open because the opening gap exceeded the limit price threshold.

Answer

The order is triggered at the market open price of 66.25andexecutesat66.25 and executes at 65.40 when the market price drops to or below the $65.50 limit price.
A Buy Stop-Limit order at 65.00Stop,65.00 Stop, 65.50 Limit requires a trade at or above 65.00toactivatethestop.WhenOmegaTechstockopensat65.00 to activate the stop. When Omega Tech stock opens at 66.25, the stop price threshold is passed, triggering the order and converting it into a Buy Limit order at 65.50.ABuyLimitordercanonlyexecuteatthelimitpriceof65.50. A Buy Limit order can only execute at the limit price of 65.50 or better (lower). Following the open, the stock trades at 66.50(abovethelimit),thenat66.50 (above the limit), then at 65.40. Because 65.40islowerthan65.40 is lower than 65.50, the limit order fills at $65.40.

Step-by-Step Solution

1
Determine order activation (trigger) condition
Order is triggered at $66.25 at the market open.
A Buy Stop order triggers when the market price reaches or exceeds the stop price (65.00).Sincethestockopenedat65.00). Since the stock opened at 66.25 (66.25>=66.25 >= 65.00), the stop condition is satisfied immediately.
2
Identify the resulting order type and execution rule
The order becomes a Buy Limit order at $65.50.
Once triggered, a stop-limit order becomes a limit order to buy at the specified limit price ($65.50) or better (lower).
3
Evaluate sequential price prints against the limit price
The order executes at $65.40.
The next trade after the open is 66.50(above66.50 (above 65.50, no fill). The subsequent trade is 65.40,whichisatorbelowthe65.40, which is at or below the 65.50 limit price, resulting in an execution at $65.40.

Key Concept

Buy Stop-Limit Order Execution Mechanics and Gapping Markets
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Topics

Types of Orders and Order Execution Strategies