Cover order is a special type of order through which the user can take an intraday position and also take advantage of extra exposure while being protected through a stop loss order.
CO is very often used in the share market.
What is the concept of “cover order”?
- When investors trade positions in the stock market, they are required to pay a margin to the broker so as to ensure that the risk involved with such a trade is almost covered.
- However, if the investor wishes to pay a lower margin and then consequently raise the leverage of such a trade, then they can choose a Cover Order (CO).
- A CO is nothing but a variant of a trading position in the stock market accompanied by a Stop Loss Order.
- This in-built risk minimization mechanism will allow traders and brokers to use higher leverage when buying and selling assets such as stocks, F&O, commodities, etc.
Constituents of a CO:
The Cover Order has two constituents, as follows:
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- The stop loss order is essential and is also compulsory for a CO.
- This stop loss order is placed simultaneously with a buy or sell order and cannot be canceled later.
- The most important point to remember for a CO is that they should be squared off before 3:10 PM every day or else they will be automatically squared off.
- Due to this, this method of the trading position will be used explicitly by intraday traders.
How does a Cover Order work?
A CO is a two-legged order, and the client needs to place a buy/sell order with a compulsory corresponding stop loss in the opposite direction.
The cover order works with the following mechanism:
- The first and foremost entry order can be a market or a limit order.
- The corresponding stop loss order will sit in the order book as a stop-loss trigger pending order. Once the trigger price hits the stop loss limit price, it will get triggered as a market order.
- The trigger price range will be defined daily, and the client must place the stop loss order within the specified range.
- Once the CO has been placed and the first leg has been traded, the client cannot cancel the CO; rather, he can only exit the current one-sided position.
- But, if the first order has not been traded, you can cancel the CO.
- Lastly, the stop loss order can be modified within the stipulated price range, and once the order has been modified, the margin will thus be recalculated.
Types of CO:
Basically, there are two types of cover orders.
They are as follows:
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Short Cover Order:
- If an investor decides to sell the shares of, say, Reliance, then it is said that the investor is going short on Reliance.
- Such a sale made through aCO is said to be a “Short Cover Order.”
- By going short, investors aim to sell their shares at a high price and then purchase them at a low price.
- Hence, the stop loss value is placed at a price above which the asset is sold.
Long Cover Order:
- It is completely the reverse of a short CO.
- Here, an investor purchases the stocks of a company through a cover order, and this concept is known as a “Long Cover Order.”
- Here, the investors purchase the shares at a low price and later sell them at a high price.
- In this case, the stop loss is placed below the purchase price of an asset.
The following are the main benefits of a cover order:
- Higher Leverage
- Reduces the risk level.
Limitations of a CO:
The following are the main limitations of a CO:
- Traders cannot drop the stop loss order but can reduce it before it gets squared off.
- Traders cannot leave an order before it is squared off during the trading day.
- If the price of the underlying asset does not hit the stop loss, then there are chances of lower capital gains and hence the order will be executed before the day ends, which is typically at 3:20 PM.
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We hope the above blog gives you a detailed idea of what a cover order is and how it functions.
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