Buying power is the amount of money you can use to buy or short stock, buy or short options, or buy or short option spreads. Buying power reduction is simply the amount of money that would be used of your total buying power if you enter a new trade. It is also referred to as the trade’s “margin requirement”. The amount of buying power required depends on your account type, such as IRA or margin, but it is based on the price of the stock.
For example, if you buy 100 shares of a $50 stock in a margin account, the buying power reduction is $2,500 because you only need to have 50% of the stock’s value because you can use leverage in a margin account. But if you buy those same 100 shares in an IRA, the buying power reduction is $5,000 because leverage is not allowed in an IRA.
If you buy an option, the buying power reduction is 100% of the option’s cost in both margin and IRA accounts. If you sell an option, the buying power reduction formula is a bit more complex, but it is roughly 20% of the stock price in a margin account. If you shorted a $50 strike put with the stock at $50, the buying power reduction would be approximately $1,000 in a margin account. In an IRA, however, the buying power reduction is equivalent to 100% of the put’s strike price -- $5,000.
If you buy an option vertical spread, for example, the buying power reduction is the cost of the vertical. If you short an option vertical, the buying power reduction is the difference between the strikes of the vertical minus the credit received. If you sell the 40/42 put vertical for .80 credit, the buying power reduction is the difference between the strikes -- $200 – minus the credit received -- $80 – for a total of $120.
You can get the buying power reductions for specific strategies in different account types from your broker by searching or asking for “margin requirements”. The minimum amount of buying power required to enter a trade is determined by FINRA, and brokers can have requirements higher than the minimum if they choose.
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