Bryant has taught graduate finance and has an MBA and master's degree in information technology.
Jason has been following ABC Widgets for some time. He thinks they're a great company, but the current price is too high for the investment to be a good value. Jason really wants to buy the stock at $5 less than it's trading now but is worried that he doesn't have the time to watch the price all day every day. He's also worried that he might not be able to get the order to buy submitted if he's busy doing something else.
Jason shares these thoughts with his advisor Tammy. Tammy tells Jason that there is a certain type of order that Jason can put in that solves problems just like this. This is conditional order known as a good 'til canceled (GTC) order. This is a standing order to buy or sell a security that stays pending until it either executes or is cancelled by the investor.
If ABC Widgets is currently trading at $110 a share, Jason can tell Tammy to put in a GTC order to buy 100 shares at $105 a share, $5 less than ABC Widgets is trading now. If the share price of ABC Widgets drops by $5 or more, than the order will automatically execute.
After talking with Tammy, Jason is happy he's found a solution to his problem. One of the reasons he's really interested in ABC Widgets is because they pay a great dividend to their shareholders. A dividend is a portion of the company's profits that are paid out directly to shareholders on a per share basis.
Whenever a company pays a dividend, the price of the stock is adjusted down by the same amount on the day that it's recorded. So if ABC Widgets is trading at $110 a share and pays a $1 dividend, the share price will be adjusted to $109.
Jason also knows that a stock split is when a company breaks up single shares into multiple, smaller share values. If ABC Widgets does a 2 for 1 stock split, each share holder will get two shares for each one they hold. So if ABC Widgets is trading at $110 a share and splits 2 for 1, each share holder will get two $55 shares for each $110 share they own.
Each of these situations is going to effect the price of the stock. Jason has worked with Tammy to put in a GTC order at a specific price that doesn't account for a dividend or stock split occurring! Jason makes a quick call to Tammy to see what might happen to his order if and when these events occur.
FINRA Rule 5330: Adjustment of Orders
Tammy listens carefully to Jason's concerns. She tells him that this is actually a common situation, and the Financial Industry Regulatory Authority (FINRA) has a specific rule on how to address orders just like this.
According to FINRA Rule 5530: Adjustment of Orders, in the case of a dividend being recorded, a GTC order price will be adjusted downward by the amount of the dividend just like the stock price on the market would be. The number of shares for Jason's GTC order will not change.
If a stock split occurs, the price of his GTC order will be split in the same manner. Using the same example of a 2 for 1 split, his order price will be divided by 2 and adjusted. In this case the number of shares for his order will adjust as well and be multiplied by 2. This way Jason will still receive the same total value of shares if his order executes.
All of these actions will be taken on automatically by the brokerage company on behalf of Jason, so there is nothing that he needs to do.
Exceptions to Adjustments
Although FINRA Rule 5330 provides for automatic adjustments, there are still times when these can be overridden. Jason could instruct Tammy to mark his order Do Not Reduce, which will prevent a target price being reduced due to events like dividends or stock splits. His $105 target price would remain the same no matter what.
Jason could also have Tammy mark his GTC order Do Not Increase preventing the purchase any more than the shares requested. If a stock split occurs for ABC Widgets, Jason's order would still be for the same 100 shares that it was before.
To review, customers can place conditional orders based on future price movements of stocks.
- A good 'til cancelled (GTC) order allows an investor to place a conditional buy or sell order for when a stock reaches a specific price.
- A stock split is when a company breaks up single shares into multiple, smaller share values, and adjusts its share value accordingly.
FINRA Rule 5530: Adjustment of Orders mandates that brokerages automatically adjust GTC order prices and share quantities in the same manner that adjustments are made for dividends and stock splits. Investors who do not want certain adjustments made to their orders can have them marked Do Not Reduce so the share price of the GTC order is not adjusted for an event such as a dividend or stock split. Alternatively or in addition, they could have it marked Do Not Increase so that the share quantity is not increased to adjust for an event such as a stock split.
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