When instructing our online discount broker as to the actions we want taken, we submit a customer order. These orders can take several different forms depending on our investment strategies and objectives. We can buy or sell; request a specific price or simply the best available price; we can stipulate an action given a particular circumstance; and we can use combinations of orders. Let’s look at the most common of these orders and the situations when we may utilize them.
This is the most common of customer orders where we ask the broker to buy or sell a stock at the best available price. It is also called an “unrestricted order” and will always be executed.
This is an order to buy or sell a specific number of shares at a certain price or better. A buy limit order can only be executed at the limit price or lower. A sell limit order must be executed at the limit price or higher. These are particularly useful on low-volume or highly volatile stocks.
An order to buy or sell a security when its price surpasses a specific price called the stop price. At that point the stop order becomes a market order. A sell stop order is placed below the current market value of the stock and is used to prevent or limit a loss or to protect a profit on a long stock position. For example, you may have purchased a stock for $20 per share and it has appreciated to $30. A sell stop order @ $25 will guarantee at least a profit of $5 per share (barring a gap-down in the price of the stock). A buy stop order is always placed above the current market price of the stock. It is typically used to protect a profit or limit a loss on a short sale (selling a stock you didn’t own by borrowing it). For example, if you sell short a stock @ $30 expecting to buy it back at a lower price but it starts going up in value instead, a buy stop order can limit your loss. It may kick in @ $32 thereby minimizing losses to $2 per share. Once the buy stop price is reached, the order becomes a market order.
Stop Limit Order:
This is a combination of a stop order and a limit order. Once activated, it becomes a limit order which means that it can only be executed at a specific price or better. The benefit is that the trader has precise control over when the order should be filled. The disadvantage is that it may never get filled. A sell stop-limit order is always placed below the current market price of the equity and is used to limit the loss or protect the profit on a long stock position. Once activated, it becomes a limit order. A buy stop-limit order is always placed above the current price of the stock and is used to limit a loss or protect the profit on a short stock position. Once activated, it becomes a limit order.
A trailing stop adjusts the stop price at a fixed percent or number of points below the market price of a stock. The purpose of the stop is to protect against a move by the stock or option price in the opposite direction than what you expect. When the price of your stock rises, the trailing stop rises with it, helping to protect you against a larger loss and eventually capturing a portion of your profit. With a trailing stop, you continue to hold the stock so you still receive the dividends from the stock, if they are paid. Should the stock plunge past your stop, your shares are sold at the next available price, not necessarily the stop price, assuming you have not placed the stop order with a limit price.
Summary of Orders entered Above the Market:
- Buy Stop-Limit
- Buy Stop
- Sell Limit
Summary of Orders entered Below Market:
- Buy Limit
- Sell Stop
- Sell Stop-Limit
- Trailing stop
Covered Call Trade Orders:
Most writers of covered calls place their trades by legging in. This where a market or limit order is placed to purchase the equity and once executed, a second order (limit) is placed to sell the option. For maximum profits, these two legs should be executed simultaneously (Buy the stock and immediately sell the option. Do not buy the stock, go to the mall and then come back home to sell the option). Another methodology permitted by some online discount brokers (not USAA, the one I use) is to place a net debit order. This is where you buy the stock and sell the option at the exact same time, not for specific corresponding prices but for a limit net debit. For example, if a stock is selling for $20 and the A-T-M call is selling for $1.50, the net debit or amount we would owe is $18.50 ($20 minus $1.50). This way, even if the price of the stock and option change, the order can still be filled if it meets the requirements of our debit order. These orders are executed via buy-write combination forms. This would be particularly useful for investors who can’t be in front of their computers but want to execute a covered call trade. As stock investors and covered call writers it is critical to know and understand the different types of customer orders and the appropriate time to implement them.
Some of our members held this stock through the May 27th and August 19th earnings reports. Unfortunately, neither report satisfied the institutional investors and the price dropped from $35 to $17…ouch. As a result, many requested that I write an article on the topic of managing stocks that have gapped down. I did so on June 19th and noted that at the time BCSI was in a trading range and seemingly outperforming the market in general. The stock fell further after the August report. Since that time, BCSI has been the subject of takeover rumors and still remains a strong company as the institutional investors are moving back into this equity. There will be a shareholder meeting next month and another ER due out on November 19th that could affect the price in either direction. Here is an updated chart for this stock:
- BCSI as of 9-17-10
Note the following significant points:
- The red arrows represent the most recent earnings reports with the gap downs.
- The green lines show the sideways trading after the first ER.
- The blue arrow shows the impressive uptrend since the last ER.
- The red oval shows a positive MACD
- The blue oval depicts an overbought situation but holding firmly above the 80%.
- The orange oval shows that these positive events occurred on higher than average volume.
- Still negative, is the 20-d ema trading below the 100-d ema but the gap is closing
Many of you have been selling calls on the stock as it has been nurtured back up from $17 to the current $24. Much can be learned from this stock and its recent history. Decisions about holding a stock through an ER, a much more aggressive strategy, must be determined based on your risk tolerance. As I have mentioned previously, a stock can gap down for other reasons and a management technique should be in place. If the stock still remains a great company in your assessment and if the chart is favorable post event, selling calls on the way up may be a good solution.
Many thanks to our members who have contributed great questions and commentary to our site. It has greatly enhanced the quality of information we share with each other. For those who read the weekly articles only, I encourage you to visit the site every day and read, contribute and join in the tremendous wealth of information our members provide to each other. Whether you are a beginner or a savvy investor with decades of experience, we can all learn from each other. Here is a link to last week’s commentary:
The recent trend continues as economic growth proceeds but at a slower pace than hoped for:
- Producer Price Index rose 0.4% in August mainly due to a rise in gas prices
- Consumer prices rose 0.3% in August once again gasoline being the main culprit
- Business inventories rose a better-than-expected 1.0% in July, a positive
- Industrial production slowed to + 0.2% from July’s figure of + 0.6%
For the week, the S&P 500 (plus dividends) rose by 1.5% for a year-to-date return of 2.4%.
IBD: Market in confirmed uptrend
BCI: Cautiously bullish selling an equal number of I-T-M and O-T-M strikes.
My best to all,
Alan ([email protected])