How is buying power calculated?
Buying power is derived from your SMA and FME.
SMA stands for Special Memorandum Account (old-timers call it the Special Miscellaneous Account). It is a journal-entry account that holds credits from certain activities in your account.
At any time, margin rules permit you to withdraw certain amounts of cash from your account. If you choose not to withdraw it today, you keep the right to withdraw it later. This money is set aside for you in your SMA, and you never lose the right to withdraw it, unless your account is in a margin call.
For example, if a stock pays a dividend, you may withdraw it. If you don't withdraw it, it is journalled into your SMA. You can "spend" SMA to buy securities.
But SMA is also created when your securities appreciate in price. For example, if I opened an account with a deposit of $100,000 cash and buy $100,000 worth of stock, my long market value is $100,000, my debit is zero, my equity is $100,000, and my SMA is $ 50,000 because I could still withdraw that much money from the account.
Your account looks like this:
$100,000 long market value
- $ 0 debit
_____________
$100,000 equity
$ 50,000 50% Reg T requirement = initial SMA
Your buying power is twice your SMA, as long as it doesn't put you into a maintenance call (that's where FME comes in so stay tuned). Therefore, in this example, your buying power is $100,000, which is twice your SMA.
If you use the buying power to buy another $100,000 in stock, your account looks like this:
$200,000 long market value
- $100,000 debit
__________
$100,000 equity
SMA = zero
Now, if your securities double in value, your account looks like this:
$400,000 long market value
- $100,000 debit
___________
$300,000 equity
SMA = $100,000
This is because your "Reg T Excess" is the amount of equity you have exceeding 50%. This gets more complicated if options are involved, but let's stay with simple common stocks for the moment. Therefore, your Reg T Excess is $100,000, and under margin rules this becomes your new SMA.
Your SMA is always your old SMA plus amounts added due to sales or closing transactions, deposits or cash or securities, dividends (including stock dividends, a little-known fact), or market appreciation, minus amounts subtracted due to purchases, withdrawals of cash or securities, or opening transactions, OR your Reg T Excess, whichever is higher.
So what has happened in this example is that market appreciation has created buying power of $200,000 in your account (again, subject to the FME limitation, which we'll discuss next).
BTW I tried this with fixed font and the numbers looked great but the whole post went down to 8-point type, so I'm going to struggle without the fixed font. If anyone can help me figure out how to do this better, I'd appreciate it, since we'll be doing a lot of numbers (wait till we get to options, yikes)....
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