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Difficulty: HardTypes of Orders and Order Execution Strategies

An investor holding a long position in stock XYZ, which is currently trading at 55pershare,placesarisk−managementorder:"Sell500XYZ50Stop,48Limit,GTC."Beforethemarketopensthenextday,negativeearningsnewscausesXYZstocktogapdownandopenfortradingat55 per share, places a risk-management order: "Sell 500 XYZ 50 Stop, 48 Limit, GTC." Before the market opens the next day, negative earnings news causes XYZ stock to gap down and open for trading at 47.50 per share. Throughout the rest of the trading session, the stock price fluctuates between 47.00and47.00 and 47.80. Which of the following statements correctly describes the status and handling of the investor's order?

  1. The order is triggered (activated) because the stock traded at or below 50,butitremainsunexecutedasanopenselllimitorderbecausethemarketpriceisbelowthelimitpriceof50, but it remains unexecuted as an open sell limit order because the market price is below the limit price of 48.Answer
  2. B
    The order is activated at the opening bell and immediately executed at $47.50 because stop orders guarantee execution at the best available price once triggered.
  3. C
    The order is automatically canceled by the exchange because the opening market price gapped below the specified limit price of $48.
  4. D
    The executing broker-dealer fills the order at $48.00 as a principal by buying the shares into its own inventory to satisfy the limit obligation.

Answer

The order is triggered (activated) because the stock traded at or below 50,butitremainsunexecutedasanopenselllimitorderbecausethemarketpriceisbelowthelimitpriceof50, but it remains unexecuted as an open sell limit order because the market price is below the limit price of 48.
A sell stop-limit order operates in two distinct phases: activation and execution. The activation trigger occurs when the stock trades at or below the stop price (50.00).BecauseXYZopenedat50.00). Because XYZ opened at 47.50 (which is below 50.00),thestopconditionwassatisfiedandtheorderwasactivated.Onceactivated,itbecameaselllimitorderat50.00), the stop condition was satisfied and the order was activated. Once activated, it became a sell limit order at 48.00, meaning it can only be filled at a price of 48.00orhigher.Becausethemarketpriceneverreached48.00 or higher. Because the market price never reached 48.00 during the trading session, the order remains unexecuted and open.

Step-by-Step Solution

1
Analyze the trigger condition of the Sell Stop-Limit order.
The stop price is 50.Theopeningtradeat50. The opening trade at 47.50 is at or below $50, so the stop order triggers (activates).
A sell stop order activates whenever a trade occurs at or below the stop price.
2
Determine the order type post-activation.
Upon activation, the order becomes a Sell Limit order at $48.00.
Adding a limit price converts the activated stop order into a conditional limit order rather than a market order.
3
Evaluate market execution eligibility.
A sell limit order at 48.00requiresamarketpriceof48.00 requires a market price of 48.00 or higher. Since the market traded between 47.00and47.00 and 47.80, the limit condition was not satisfied.
Limit orders guarantee a minimum price requirement and will not fill below the limit price.

Key Concept

Sell Stop-Limit Order Execution Rules
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Topics

Types of Orders and Order Execution Strategies