Payoff profiles of price-contingent orders
Solid lines represent the transactions that occur with the execution of the order
Dotted lines are existing exposures that are reversed by the execution of the order
Price below limit
Price above limit
Payoff
Buy
Payoff
50
Price
0
50
55
Price
-5
The LIMIT BUY order initiates a long exposure.
The client believes that this stock is not worth more than 50. She
instructs the broker: “Buy at ANY price below 50”
Sell
Payoff
0
The STOP BUY order reverses a short exposure. The existing short means
that the client is losing when the price goes up. To limit her loss, she
instructs the broker: “Buy the moment the price hits 55”
Payoff
45
50
Price
50
Price
-5
The STOP LOSS order reverses a long exposure.
The client is worried that the price is falling and wants to limit her loss to
at most 5. She instructs the broker: “Sell the moment the price hits 45”
The LIMIT SELL order initiates a short exposure.
The client wants to bet on a downward movement in price and instructs
the broker: “Sell at ANY price above 50”