What Is a Cash Trigger?
A cash trigger is a condition that triggers an investor to make a trade or take a specific action, such as buying or selling a financial product such as a stock, option, futures contract, bond, or currency. Self-imposed cash triggers are most common among retail investors. They include deciding to make a purchase if a stock rises above a predetermined price, or selling a stock if it falls below a specific price.
Market-imposed cash triggers can occur on over-the-counter options, when a transaction or action is taken, or when the price of an asset reaches a certain level.
- A cash trigger is called that because it is an action, like a trade, that is triggered and adds cash to your trading account.
- There are many kinds of triggers traders can set for their trades, for example, stop-loss orders and stop-buy orders.
How the Cash Trigger Works
A cash trigger is a price at which an investor takes action. Traders often put out orders at these levels, so that when the price reaches a predetermined level, they can enter or exit a trade.
For example, if a trader is long a stock at $20, but wants to get out of the trade if the stock falls below $15, they could put a stop-loss order at $15. The stop-loss order gets them out of the trade if the price drops below $15, with $15 being the trigger price as well as the order price in this case.
It's important to note, however, that the transaction becomes a market order once the stop-loss trigger is activated. This means that the actual sale price might occur below your trigger point. This becomes especially important with volatile stocks or extreme market volatility because the sale price could wind up being significantly below the stop trigger.
Similarly, if a trader has been watching a stock start to move higher after a prolonged decline, they may decide to buy the stock, but only if it keeps rising above a prior peak. If the former price peak was $60, the trader could place a stop buy order just above $60. The order won't fill until the price moves above $60. The cash trigger is $60, though in this case, it is also where an order can be placed.
These are referred to as cash triggers because they result in an inflow or outflow of cash from the account.
Some investors choose to set alerts instead of orders at cash trigger levels. In the case above, instead of placing an order the investor may simply watch the price and then execute a trade manually at the cash trigger level.
Other Types of Cash Triggers
In a knock-in option, the option only comes into existence if the underlying asset reaches the knock-in price. This could result in additional premiums being paid and new obligations or rights on the new option.
In a knock-out option, the option ceases to exist if the underlying asset touches the knock-out price.
Such products trigger something when a specific price is reached. Unlike the other self-imposed cash triggers mentioned above, these types of triggers are built into the product.
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