Determining Buying Power
Buying power serves as a measurement of the dollar value of securities that one may purchase in a securities account without depositing additional funds. In the case of a cash account where, by definition, securities may not be purchased using funds borrowed from the broker and must be paid for in full, buying power is equal to the amount of settled cash on hand. Here, for example, an account holding $10,000 in cash may purchase up to $10,000 in stock.
In a margin account, buying power is increased through the use of leverage provided by the broker using cash as well as the value of stocks already held in the account as collateral. The amount of leverage depends upon whether the account is approved for Reg. T margin or Portfolio Margin. Here, a Reg. T account holding $10,000 in cash may purchase and hold overnight $20,000 in securities as Reg. T imposes an initial margin requirement of 50%, which translates to buying power of 2:1 (i.e., 1/.50). Similarly, a Reg. T account holding $10,000 in cash may purchase and hold on an intra-day basis $40,000 in securities given ib
’s default intra-day maintenance margin requirement of 25%, which translates to buying power of 4:1 (i.e., 1/.25).
In the case of a Portfolio Margin account, greater leverage is available although, as the name suggests, the amount is highly dependent upon the make-up of the portfolio. Here, the requirement on individual stocks (initial = maintenance) generally ranges from 15% - 30%, translating to buying power of between 6.67 – 3.33:1. As the margin rate under this methodology can change daily as it considers risk factors such as the observed volatility of each stock and concentration, portfolios comprised of low-volatility stocks and which are diversified in nature tend to receive the most favorable margin treatment (e.g., higher buying power).
In addition to the cash examples above, buying power may be provided to securities held in the margin account, with the leverage dependent upon the loan value of the securities and the amount of funds, if any, borrowed to purchase them. Take, for example, an account which holds $10,000 in securities which are fully paid (i.e., no margin loan). Using the Reg. T initial margin requirement of 50%, these securities would have a loan value of $5,000 (= $10,000 * (1 - .50)) which, using that same initial requirement providing buying power of 2:1, could be applied to purchase and hold overnight an additional $10,000 of securities. Similarly, an account holding $10,000 in securities and a $1,000 margin loan (i.e., net liquidating equity of $9,000), has a remaining equity loan value of $4,000 which could be applied to purchase and hold overnight an additional $8,000 of securities. The same principals would hold true in a Portfolio Margin account, albeit with a potentially different level of buying power.
Finally, while the concept of buying power applies to the purchase of assets such as stocks, bonds, funds and Forex
, it does not translate in the same manner to derivatives. Most securities derivatives (e.g., short
options and single stock futures) are not assets but rather contingent liabilities and long options, while an asset, are short
-term in nature, considered a wasting asset and therefore generally have no loan value. The margin requirement on short
options, therefore, is not based upon a percentage of the option premium value, but rather determined on the underlying stock as if the option were assigned (under Reg. T) or by estimating the cost to repurchase the option given adverse market changes (under Portfolio Margining).