CFA CFA Level 1 Stop-Limit orders

Stop-Limit orders

  • This topic has 1 reply, 2 voices, and was last updated Dec-20 by fp92.
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  • lucho37
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    Hi,

    I have a doubt about a question from the CFAI material regarding orders.

    Question

    Jim White has sold short 100 shares of Super Stores at a price of $42 per share.

    He has also simultaneously placed a “good- till- cancelled, stop 50, limit 55 buy”

    order. Assume that if the stop condition specified by White is satisfied and the

    order becomes valid, it will get executed. Excluding transaction costs, what is

    the maximum possible loss that White can have?

    A $800.

    B $1,300.

    C Unlimited

    Solution

    B is correct. The maximum possible loss is $1,300. If the stock price crosses $50,

    the stop buy order will become valid and will get executed at a maximum limit

    price of $55. The maximum loss per share is $13 = $55 – $42, or $1,300 for 100

    shares.

    Let’s say it closes at $45 and the next day it gap opens at $60 because of a great ER. The condition of stop 50 is met but nobody is selling at 55 or less, so how is there a limit in the possible loss when the order cannot be executed? The stock goes to the moon and you can’t find anybody willing to sell between 50 and 55…

    What am I missing here?

    Thanks

    fp92
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    Hi @lucho37 , the question asks what is the maximum loss Jim can experience, so B is correct given the $55 limit buy.

    In the theoretical case you had mentioned, yes stop will be activated, but given the $55 limit, there will be no buys executed. When there are no purchases of stock executed at above $55, there are no losses realised.

    Does this make sense?

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