Stop Orders and Stop Limit Orders

A stop order is a dormant instruction. It has no price of its own until something in the market reaches the stop price, and then it converts into a different order type entirely. Read the two rules as a trigger and a result: what fires the order, and what the order becomes when it fires.

What Do the Two Orders Become When They Trigger?

The NYSE American options order types rule and the NYSE Arca options order types rule define both types in identical language.

• A Stop Order becomes a Market Order when the market for a particular option contract reaches a specified price, which the rules call the triggering event.
• A Stop Limit Order becomes a Limit Order when the market for a particular option contract reaches a specified price.

After the triggering event, each becomes a new order under the Market Order or Limit Order paragraph of its own rule, and is processed as such.

The rule says the triggered Stop Order is processed as a new Market Order and no more. The Market Order paragraph's receipt-time quote conditions, rejection during Core Trading Hours without both national quotes and trade collar protection where only the same-side quote is there, are the natural reading, though the rule does not say the trigger counts as receipt.

That conversion is the whole point of the type, and it is where most wrong answers live. A triggered Stop Order takes the best price obtainable when the order reaches the Exchange, which can be worse than the stop price. A triggered Stop Limit Order takes its specified price or better, so it may not execute at all.

Exam Tip: Gotchas

• The stop price triggers a Stop Order and does not limit its execution. The triggered order becomes a new Market Order executed at the best price obtainable, which can be worse than the stop price.
• A triggered Stop Limit Order can go unfilled. It becomes a new Limit Order at its specified price or better, and a market that keeps moving away leaves it resting.

What Counts as the Triggering Event?

The trigger clause is the same in both rules and it offers two alternatives, not one.

A Stop Order to buy (sell) is triggered when the option contract trades at a price equal to or greater (less) than the specified stop price on the Exchange or another Market Center, or when the Exchange bid (offer) is quoted at a price equal to or greater (less) than the stop price.

The Stop Limit Order carries the identical clause. Both rules then restate the trigger a second time inside the standing clause, as same-side incoming interest that trades or quotes at a price equal to or better than the stop price.

Two details in that sentence are tested.

• A trade on another Market Center triggers the order. The trade does not have to happen on the exchange holding the order.
• A quote alone triggers it. No transaction is required where the Exchange bid or offer reaches the stop price.

The FINRA stop orders rule is a separate instrument with its own trigger and its own permission, and it is covered in the unit on meeting obligations to customers regarding orders. So is the FINRA adjustment of orders rule, which decides what happens to an open stop order when the security goes ex-dividend or splits.

Exam Tip: Gotchas

• Under both options rules, trading and quoting are alternatives joined by "or". An answer requiring an actual transaction at the stop price ignores the second half of that clause.
• The triggering trade can happen away from the exchange. The clause names a trade on the Exchange or another Market Center, so an off-exchange print at the stop price fires the order.

Where Does an Untriggered Stop or Stop Limit Order Rest?

Neither order sits in the visible book before it fires. Under both options rules, a Stop Order and a Stop Limit Order are not displayed and have no standing in any Order Process in the Consolidated Book, unless or until triggered.

Both are Contingency Orders or Working Orders, the rules' two-name defined term, so both are maintained in the Working Order File of the Consolidated Book until they are eligible for execution and/or display.

Exam Tip: Gotchas

• An untriggered stop order has no standing at all. It is not merely lower in priority than displayed interest; the rules say it has no standing in any Order Process until the triggering event.

Does the Equities Rule Define a Stop Order?

No. The NYSE Arca equities order types rule defines no Stop Order and no Stop Limit Order. Its catalogue of primary order types runs to Market Orders, Limit Orders and Inside Limit Orders.

If a question puts a stop order on an equity order-types fact pattern, the definition it is testing comes from somewhere else: the FINRA stop orders rule, covered in the unit on meeting obligations to customers regarding orders, because the two options rules define a stop order for an option contract only.

Exam Tip: Gotchas

• A blank in the equities rule is a fact about that rule. The absence of a stop order definition there is not an oversight to fill from the options rules, whose definitions are written in option contracts and reference the Consolidated Book.

What Should You Check on Exam Day?

• Name what the order becomes. A Stop Order becomes a new Market Order; a Stop Limit Order becomes a new Limit Order.
• Check whether the fact pattern supplies a trade or a quote. Either one triggers the order under both options rules.
• Check where the triggering trade happened. A print on another Market Center at the stop price fires the order.
• Before the trigger, treat the order as absent from the book. It is undisplayed, has no standing in any Order Process, and rests in the Working Order File.
• If the scenario is an equity order under the exchange rules, remember that rule defines neither type, so the definition must be coming from another rulebook.