Best Practices

What’s the Deal with “Buying Power Reduction”?

| Dec 7, 2015
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    Best Practices

    What’s the Deal with “Buying Power Reduction”?

    Dec 7, 2015

    Retail traders were at a disadvantage before thinkorswim empowered them with tools only professionals had before, such as measures of buying power reduction and is important because it can help maximize your potential profit. You don't need to know all the details but you need to understand the general concept and this will help.

    The initial amount of capital required to place a trade is Buying Power Reduction (BPR). Total buying power is our capital available to place trades. Knowing this we can better understand our potential return on capital and size our trades appropriately.

    Tom and Tony by discussing defined risk trades and how BPR works there. They provide a helpful example. They also note that for such trades BPR is static and will not change throughout the life of the trade.

    Undefined (naked short) options are different. Tom and Tony explain how they work too. For both calls and puts the BPR is the largest of 3 calculations for standard margin accounts with naked options permissioning. A table of the formula for the buying power reduction (BPR) for both calls and puts and both were displayed. Should the underlying moves against your short position BPR will increase. A graph of the buying power reduction (BPR) versus the underlying price on an XYZ stock trading at $200 with a short $197 put trading at $1.00. The graph showed how the BPR increases as the underlying moves against the short position.

    Tom and Tony explained how cheap options can mitigate BPR, especially in an IRA account. A table comparing EWZ positions with EWZ trading at $23.91 in both a margin account and an IRA account was displayed. The table included the position, credit, probability of profit (POP), buying power reduction (BPR) and BPR per $1 of premium for both types of accounts.

    Watch this segment of “Best Practices” with Tom Sosnoff and Tony Battista for the takeaways and other important information on using the knowledge of buying power reduction (BPR) to compare the risk of trades in your portfolio and how understanding this can help mitigate the effects of BPR in your account and especially your IRA account.

    This video and its content are provided solely by tastylive, Inc. (“tastylive”) and are for informational and educational purposes only. tastylive was previously known as tastytrade, Inc. (“tastytrade”). This video and its content were created prior to the legal name change of tastylive. As a result, this video may reference tastytrade, its prior legal name.

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