When one enters a trading position in the margin market or makes an intraday trade, one must have a minimum margin amount. The margin is for the broker to cover the risk of a trader, which the stock broker insists upon to provide leverage based on the minimum margin. What if one wants to pay a lower margin and get higher leverage? According to SEBI guidelines, there are some rules and regulations for margin trading.
In the cover order, there is a mechanism that has built-in risk mitigation. The advantage of this mechanism is that it not only reduces the risk for the broker but also enables the trader to get higher leverage. To understand the meaning of cover order, one can follow along with a deep, in-depth explanation about what cover order is and what the use of cover order is in the share market when a trader trades a position in the stock market. This position can be important for brokers as they can trade in equity cash, equity futures and options, commodities, and more. Due to high-risk associated methods like cover order margin used in the following trade.
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What is a Cover Order (CO)?
A cover order is a special purchase order with a risk reduction feature. It is a market or limit order which gives an extra perk combined with a stop loss order, which is like a cherry on the cake for traders. The benefit of the covered call is that once a trader places a stop loss order, they know the amount of money they can lose is limited; here are some things one must note:
The stock broker system will take two orders:
- A market or limit order
- A stop loss market will be executed only when their stop loss condition is met.
When the trigger price is met, the stop loss order is executed as a market order. A cover order is used when both of these orders are placed simultaneously. Cover orders allow one to limit potential or heavy losses.
Once set, one cannot cancel the stop loss because, in the cover order, it is either a market or a limit order with a mandatory stop loss order in a specific range. Using a stop loss will ultimately reduce the risk. A cover order in the share market should be squared off the same day, and it is used only for intraday positions. If not squared off by the trader, the system will initiate automatic squaring off.
There are two types of cover orders, which are as follows:
Long Cover Order
A long cover order is an order that a trader executes when they want to buy stocks during trading hours. Moreover, it implies that the trader is following a bullish trend to buy stocks. The long cover order is placed with a stop loss order at a price that is lower than the buying price of a stock.
Short Cover Order
If a trader wants to sell stocks, then they can place a short cover order. Here, they can place the stop loss, which will be higher than the stock price. The short cover order is similar to the long cover order.
Working of a Cover Order
A cover order is a two-legged order, where the first leg can be defined as buy or sell, and the second one is the corresponding stop loss order in the opposite direction. One can also consider the first leg as a parent order and the second leg as a child order. One can do CO from most of the stock brokers. The Share India platform also provides the CO order in their app and trading website.
- The first entry order in a CO is always a limit order.
- Subsequent lead orders, which create a position, can be limit- or market-based on the stop loss order.
- The stop loss order sits in the order book as a pending order triggered when the price reaches or crosses the trigger price.
- Once triggered, the stop loss order becomes a normal limit order (SLL) or a normal limit order (from ALL).
- On many platforms, the second leg of CO is always an SLL.
- The first leg serves as a stop loss position creator order.
- The trigger price range can be specified within the stop loss range to ensure execution within a specified price range.
- Once the first leg of CO is traded, the second leg cannot be cancelled, only modified.
- CO is primarily used for intraday trading, where the trader’s position is auto-squared off by the system within the trading timeframe.
- If the second leg of a CO is rejected or cancelled, the trader can regenerate it or contact the broker to square off the position.
- CO is available for equity, futures and options, currencies, etc.
Example of a CO Trade
In an intraday trade, a trader can buy shares at ₹100/- and then place a stop loss at ₹90 and the target price at ₹120 with a bracket order. In scenario one, when the stock price goes down, the stop loss will be executed, and the position will be squared off. But in other scenarios, when the stock price rises and touches the target price, the position will be exited. And in case of a pending position, the trade will be squared off by the system.
Benefits of Cover Orders
There are two significant benefits from the cover order: one can get high leverage, and the risk is low due to its mechanism. That cuts short the potential risk of one’s trade.
- Investors can enjoy high leverage on the trading position through the cover order. This high leverage can be explained as equity cash can be as high as 30 times the contract value.
- As one places a cover order, the risk associated with their trading position goes down dramatically. The reason for the lower risk is due to the stop loss order. As it also cuts down the task of following the stock price constantly.
- A cover order provides better control over one’s trade. The key lies in the strategy of the trade.
Drawbacks of Cover Order
One of the major drawbacks of a cover order is that traders cannot cancel the stop loss order. Although one can modify the cover order, traders cannot exit the order before the trade is squared off. If the stop loss is not triggered, then the asset can also automatically be squared off, resulting in lower capital gains of trade.
Conclusion
The cover order method assists traders in reducing downside risks and provides them with better control over risk management in intraday trading. It can assist traders in trading more systematically because trade is always under the watch of a stop loss. Traders can leverage their position using significant facilities such as margin and increasing the investment capital for their trade. Overall, it minimises the downward risk of trade without doing any further action.
Greater exposure helps the trader to utilise their trade and place proper stop loss and limit on their trade. The significant advantage is that the trader can choose the loss and take a smart approach. One can check out the Share India app to place intraday trade. There is also an option for cover orders for one’s trade.
