Buying power and excess margin

Buying Power and Excess Margin

Buying power is the amount of excess margin you have available in your account. With a 50% margin requirement, simple mathematics says that any given amount of buying power (excess equity) can buy twice that amount in additional securities.

What is Buying Power (Excess Equity)?

Let's use the Disney example again where the stock has just increased in price by $20 per share. Your margin account would look like this:

Current Market Value	$10,000 (100 shares x $100/share)
Debit Balance	$5600 (the original Eagle Traders loan)
	-----------
Equity	$4400

As you recall from our hypothetical example, when you originally purchased the stock, the equity in your margin account was $2400, so you now have an unrealized, or paper profit, in your account of $2,000. You could realize that profit immediately by selling your Disney shares, repaying your Eagle Traders loan, and withdrawing the $2,000 in cash, minus interest charges of course.

But you may not want to close out your Disney position. Perhaps you think the shares will go even higher. Meanwhile, though, you really would like to somehow take advantage of the paper profit you already have.

And there is a way to do that in a margin account. You can't take advantage of all the profit, but you can use part of it. That's the part known as Excess Equity and here's how it's calculated:

Take the current market value of your stock position and calculate how much of your own money you would have to put down if you were buying the stock at this current market value. In our case, and given the 30% initial margin requirement, that amount would be $3,000 (30% * $10,000).

Now subtract that initial margin requirement from the equity now in your account. You will find that you have a surplus of $1400 in equity and it is this surplus that is known as Excess Equity (EE).

Put another way, the formula for determining excess equity goes like this:

EE = Equity - (stock's current market value x initial margin requirement)

There are two things you can do with your $1400 in excess equity:

You can withdraw it as cash. This is essentially like getting a cash advance from a credit card and, like the credit card, the advance increases your indebtedness. Your debit balance will increase by $1400.
You can use your excess equity to purchase more stock on margin. For example, given the 50% initial margin requirement, your $1400 excess equity is the down payment on $2800 worth of stock. In this case, your debit balance would increase by $2800: consisting of the $1,000 excess equity "credit line" and the $1400 Eagle Traders loan.

There is one thing you cannot do with excess equity:

You cannot use it to pay off your debit. As mentioned earlier, the only way you can do that is by depositing funds into your account.

To repeat, with the current 50% margin requirement, your buying power in the example above is equal to twice the amount of your excess equity or in this case, $2800.

Please note that you have to check the buying power in your account daily, because buying power fluctuates with the market price of the stock.