As a follow up to yesterday’s licensing exam study question, here is your question PLUS answer and rationale:
Todd finally hit the nail on the head when he sold short shares of Widget Corporation. He doesn’t see widgets coming around anytime soon, but would like to protect his profits in case the stock goes against him. What type of order would Todd most likely enter?
A: Buy stop
B: Sell Stop
Correct Answer: A
Rationale: Buy stop orders are commonly used to limit a loss or protect a profit on short sales. Because shares are sold to open a short position, they would need to be bought back in order to close the position. A stop order triggers a sale or purchase if the stock reaches a certain price. In this case, Todd would place the order above the current market and if the stock price increased to his ‘stop price,’ the order would become a market order and close his position. The order would still allow for Todd to potentially profit if the stock goes down. If a market order was entered, the stock would be immediately bought at the next available ask price. A Fill or Kill (FOK) is an order distinction used for limit orders which requires that all of the order be executed immediately and completely or cancelled.
*Questions featured in the weekly study question series are sampled from Solomon’s industry-leading Online Exam Simulator.