Speaker A
[Music] Be talking about buying power here. Everything you need to know about buying power. This should answer a lot of your questions here. Um, so we'll get into it. Let's do it.
Comprehensive guide on buying power in options trading, covering account types, leverage, risk management, and strategies to optimize buying power in 2023.
Key Takeaways
- Buying power varies significantly by account type and position structure.
- Static buying power in IRA accounts contrasts with dynamic buying power in margin and futures accounts.
- Buying power serves as a practical risk estimate for options traders.
- Risk-defined strategies like buying wings can reduce buying power, especially in cash accounts.
- Effective management of extrinsic value and position rolling can optimize capital deployment.
Summary
- Buying power requirements differ between IRA/cash accounts, margin accounts, futures, and portfolio margin accounts.
- IRA accounts have static buying power requirements as positions are cash secured, while margin accounts offer leverage but with fluctuating buying power.
- Factors influencing buying power include volatility, underlying asset status, proximity to strike price, and intrinsic vs extrinsic value.
- Buying power is a useful proxy for estimating realistic risk on an options position.
- Strategies to reduce buying power include buying cheap wings to define risk, using synthetic stock positions, and employing spreads or futures.
- Margin accounts may sometimes require more buying power for spreads than naked positions due to risk calculations.
- Futures trading offers additional leverage but with more dynamic and potentially volatile buying power requirements.
- Managing extrinsic value and rolling winning positions can optimize buying power usage and reduce opportunity costs.
- Avoiding inverted positions is important as they can double buying power and risk.
- Different account types rank by buying power volatility: IRA (least), margin, futures, and portfolio margin (most volatile).
Chapters
- 00:00Introduction to Buying Power
- 00:42Factors Affecting Buying Power
- 01:23Buying Power as Risk Proxy
- 02:05Buying Power in IRA vs Margin Accounts
- 02:37Ranking Buying Power Volatility by Account Type
- 03:44Strategies to Reduce Buying Power
- 04:24Margin Account Nuances and Synthetic Positions
- 05:05Futures Trading and Span Margining
- 06:33Buying Power vs Extrinsic Value and Opportunity Cost
- 07:18Managing Winning Positions and Rolling
Full Transcript — Download SRT & Markdown
Speaker A
Beautiful. All right. So, in an IRA/cash account, there are same sort of buying power requirements there. Your positions are going to be cash secured to the notional value of that position. Uh, in a margin account, you get that buying power
Speaker A
relief. It comes out to be roughly 15 to 20, 25% of the notional value of whatever that position is. Buying power, it'll differ between underlying, it'll differ between volatility, um you know, differences in volatility between those underlyings, the status, if it's a hard
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to borrow stock or one that's not hard to borrow, and the proximity of the stock price to uh the strike that you're using or the spread that you're you're using. Uh the intrinsic value versus the extrinsic value. That all comes into
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play when we talk about buying power. So this value, the buying power requirement is non-static. It can change based on all of these factors or changes in these factors. So volatility increases, you're likely to see buying power increase. If the uh stock goes
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down and it's testing your put strike, you might see buying power increase a little bit. If the put goes in the money, you're going to see buying power increase. So, it's not static, but it's not going to explode in your in
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your face most of the time unless it goes very, very deep in the money on that position. So, when you're looking at your position, the initial buying power requirement is a good proxy for or an estimate for the realistic risk you
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could see on that position. So, we get that question all the time. If you sell a strangle, you know, you have theoretically unlimited risk. Or if you sell a put, the stock, if the stock goes to zero, you'd lose x amount. When you
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look at the buying power requirement, that's a good way to gauge kind of your the estimate or at least the broker's estimate of what that risk is on that position. In an IRA account, buying power is going to be static. So, if you
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sell the put, no matter what happens with the stock, the buying power is not going to change. Uh with spread trades, if you sell a spread, the buying power is never going to change on those positions. So, you know, buying power is
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going to be static in an IRA account, you're never going to come into issues with, you know, going above your your buying power availability.
Speaker A
So, an example for an IRA account, if you sell the 100 strike put, you will use around 10 or you will use 10 grand in buying power less, whatever the credit is that you're you're selling that put for. The same position on
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margin count. It's going to use about two grand in buying power. Maybe 2,200, maybe 1,500, somewhere between 15 and 25% of the notional value for that same position. So, you get significant leverage about 3 or 4x to what you get
Speaker A
for, you know, a cash secured position. Yeah. And if we were to rank them for uh buying power requirement and how volatile that can be, the IRA account is going to be your least volatile because it's cash secured. Then you have your
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margin account which still fluctuates. Uh then you have trading futures in a margin account because margin uh futures margin is generally has more leverage.
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And then portfolio margin where you you don't have to put up nearly as much to hold the same notional value position.
Speaker A
That's going to be your most volatile. So depending on what you're trading, there can be bigger differences in buying power changes, but uh keep that in mind when you're placing positions.
Speaker A
Good stuff. Get on to the next slide here. So quick ways to reduce the buying power. So we talk about buying cheap wings. This is very much applicable to IRA and cash accounts. There's almost never a case where I wouldn't buy some
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sort of wing to define the risk and reduce the buying power requirement. It's just a matter of how much you're willing to pay to buy that that option.
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So, you know, selling the puts, you can get that same sort of exposure, you know, with with the naked put, buying a cheap one, two, three, five delta option just to define the risk and and cut that buying power. For a margin
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account, it's important to understand that your your margin requirement for a naked position could be less than a spread that has defined risk. And that's because you sort of have that built-in uh risk metric on that naked position.
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So if you're looking if you're in a margin account, compare the the spread to a naked position. You might be be better off just being naked in that position from a buying power perspective. Remember it's going to be
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the greater of the two between uh the you know the a spread is always going to be margin to the risk the max risk whereas the the naked put you know is calculated based on volatility and status and proximity to the strike and
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time until expiration. So just keep in mind that defining risk isn't always going to reduce your buying power in a margin account using uh synthetic stock positions. So you can look at poor man's covered calls, poor man's covered puts,
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zebras as alternatives to being long or short the stock or doing covered calls/covered puts. You'll definitely see buying power uh difference in those positions and you'll see it a lot less a using a lot less buying power with the poor man's
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covered call, poor man's covered put zebra futures. So futures you get additional leverage your span margined on those positions. So your positions even with spread trades will be less buying power than the max risk. So if you are putting
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on futures positions, keep in mind that your your buying power requirement on those positions is going to be much more dynamic than a margin account and can you know get much bigger based on movements in that futures position uh
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with the the future getting closer to your strikes or volatility changing time uh passing. All those factors are going to come into play with your futures positions and span margining managing positions. So buying power usage verse extrinsic value. There's a
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an opportunity cost there. So one of the quick ways that you can just reduce your buying power and reduce your risk as well is is relative to the extrinsic value you have on that position. Right?
Speaker A
So, we talk about not keep, you know, not holding positions all the way to expiration because the amount you can gain in value is is negated by the amount of buying power you're using to hold that position. If you're using a
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thou $1,000 in buying power to hold a 10 cent put option, you only have 10 cents more to make. And you know, that's a lot of capital that you could be deploying elsewhere. That is a that is an opportunity cost to you. So when you
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look at all your positions, take into account how much extrinsic value you have on that position, how much buying power it's using, and whether that opportunity cost is worth it in that in that duration relative to something that
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you can put on in a in a further out expiration. Also, by managing your winning positions, rolling, you know, those winning positions and rolling that capital into new higher extrinsic value opportunities, that'll reduce your buying power because you're taking off
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risk, shorter duration risk, lesser extrinsic value risk, and rolling into bigger meteor positions that have higher upside for you further out in time.
Speaker A
Yeah. And if you're in an IRA account, it's not the end of the world. If you're worried about it, there's always strategies that we can use to manipulate the buying power and reduce the buying power like zebras, like wider
Speaker A
spreads, things like that. Yep. Finally, changes in buying power. So, a couple reasons or a couple uh things that will definitely change your buying power. So, inverted positions. So, your buying power is going to increase via that intrinsic value. So, if you sell a
Speaker A
put and it uses a $1,000 bucks in buying power and that put goes $5 in the money, y
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positions that go in the money, you're going to see intrinsic value on those, you're going to see added buying power requirement on those positions.
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with spread trades specifically and why, you know, we tend to not manage our spread trades as much as our naked positions. Buying power will increase on inverted spread trades because you're doubling the risk and you're you're going to be using double the buying
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power. So, if your put spread is closer, you know, is uh inverted to your call spread, you could theoretically lose on both those positions, which means you're going to be margined on both those positions. You're going to be using two
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times the buying power on those positions. So, if you're trading spreads, the most you can do is get to really at the money or uh at the same strike for those short options. Can't really go any further than that for your
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spread trades. You can also use additional buying power when you're unbalanced on your spread trade. So, if you're doing dynamic iron condors or maybe you're just adding positions in, if you're selling a $5 wide put spread versus a $10 wide call
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spread, you're going to use the greater of the two, the great the the max risk on the total position is going to be your buying power requirement. So, you're going to use a little bit more buying power if you have unbalanced
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positions. And then, of course, the changes in IV or if the the status of that stock changes. So if volatility increases all else equal, you're going to see an increase in buying power requirement because there's more projected range of that price or of that
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underlying price movement. So you're going to see buying power increase. Uh as well as if you know a stock becomes hard to borrow, if something crazy happens, if there's a short squeeze or something like that, you could definitely see uh your buying power
Speaker A
requirement increase in that case. Lovely. just lovely. Um, yeah, I think the biggest thing is with iron condors, things like that, not going inverted, um, just because the buying power doubles, your risk doubles. It's different than a strangle in the sense
Speaker A
that you already had undefined risk. So, you can actually reduce your buying power in some cases when you're picking up more extrinsic value. But yeah, big change and difference there.
Speaker A
Good stuff.
Topics:buying poweroptions tradingmargin accountIRA accountportfolio marginfutures tradingrisk managementoptions strategiesextrinsic valueleverage
