SMA

This section covers some of the more difficult margin concepts and typically isn’t heavily tested. Aim to understand the ideas and build familiarity, but don’t spend a disproportionate amount of time trying to master every detail.

When a margin account gains value, it also gains additional buying power (in a long account) or selling power (in a short account). In plain terms, the investor can buy more shares (or sell short more shares) without making an additional cash deposit.

When a margin account gains value, it also creates special memorandum account (SMA).

You can think of SMA as a credit line. As the account builds equity, the broker-dealer effectively allows more borrowing capacity. That borrowing capacity can be used to:

• Buy (or sell short) more securities without depositing new cash
• Withdraw cash from the account

SMA for long accounts

To see how SMA is calculated, work through a typical question:

An investor purchases 100 shares of stock at $80 and deposits the Regulation T requirement. The stock rises to $120 per share. What is the buying power in the account?

Start with the equity formula at the time of purchase:

$8,000 (LMV) - $4,000 (debit) = $4,000 (equity)

The investor buys $8,000 of stock (100 shares × $80). Under Regulation T, the investor must deposit the greater of 50% of the purchase price or $2,000. Here, 50% is larger, so the investor deposits $4,000. The remaining $4,000 is borrowed from the broker-dealer, which shows up as the debit.

Now update the equity formula after the stock rises to $120 per share:

$12,000 (LMV) - $4,000 (debit) = $8,000 (equity)

You can also express equity as a percentage (not required to answer the question, but helpful for context):

Equity % = $8,000 (equity) / $12,000 (LMV) Equity % = 66.7%

The account is now above 50% equity, so it has excess equity (equity above 50%). Use this formula:

$$\text{Excess equity}=\text{equity - 50\% of LMV}$$

Compute it:

Excess equity = $8,000 (equity) - $6,000 (50% of LMV)

Excess equity = $2,000

In most questions, excess equity and SMA are the same (we’ll cover when they can differ later). Here, SMA is $2,000.

An SMA of $2,000 gives the investor two choices:

• Buy $4,000 of new stock without depositing any new money
• Withdraw $2,000 of cash from the account for any purpose

Why can $2,000 of SMA support a $4,000 purchase? Because new purchases in a long margin account require a 50% deposit. If the investor can “cover” the required 50% using SMA, they can buy twice the SMA amount.

That’s why buying power = 2 × SMA.

Re-state the account before using SMA:

$12,000 (LMV) - $4,000 (debit) = $8,000 (equity)

SMA = $2,000

Now, assume the investor uses all their SMA to purchase $4,000 of new stock without making a new deposit. What happens to the equity formula?

Can you figure it out?

The investor can also withdraw SMA as cash and use it for any purpose. Some investors use margin borrowing as an “any-purpose” loan, using securities as collateral.

Re-state the account before withdrawing SMA:

$12,000 (LMV) - $4,000 (debit) = $8,000 (equity)

SMA = $2,000

An SMA level of $2,000 allows the investor to withdraw up to $2,000 from their account for any purpose. If this occurs, what happens to the equity?

SMA functions like a margin account’s credit line: as the account value rises, SMA is created. You’ve already seen SMA calculated using excess equity, but there’s another common shortcut:

For every $1 the LMV increases, the SMA increases by $0.50.

Now try a longer question.

An investor purchases 200 shares of stock at $150 per share in their margin account and makes the required Reg T deposit. The market price rises to $190 per share. Answer these questions:

What is the equity (in $ and %)?

What is the excess equity / SMA?

What is the buying power?

How much may they withdraw in cash?

How far can you get?

In the examples above, excess equity and SMA matched. That’s common, but they can diverge.

Here’s the key relationship:

• If the market value rises, both excess equity and SMA increase.
• If the market value later falls, excess equity falls, but SMA does not fall.

SMA is only reduced when it’s used (by purchasing securities using buying power or by withdrawing SMA as cash).

That’s why SMA is sometimes called a margin account’s “high water mark.” SMA is created when LMV rises, and it remains available even if LMV later declines - unless using it would push equity below minimum maintenance (25%).

Sidenote

SMA in restricted accounts

We discussed restricted accounts in the previous section, which are accounts below 50% equity. When a security is sold in a restricted account, at least half of the proceeds must be used to pay down the debit balance. There’s one more rule to remember here: half of the sales proceeds are credited to SMA.

Don’t overthink this. When a security is sold in a restricted account, remember:

• 50% pays down the debit
• 50% is credited to the SMA

SMA for short accounts

The concept is similar for short accounts, but the mechanics use SMV (short market value) and a credit balance.

An investor sells short 400 shares of stock at $50 and deposits the Regulation T requirement. The stock falls to $35 per share. What is the selling power in the account?

*Instead of buying power, we call it selling power in short accounts. The idea is the same: selling power is the amount of additional stock that can be sold short without depositing more money.

Start with the equity formula at the time of the short sale:

$30,000 (credit) - $20,000 (SMV) = $10,000 (equity)

The short sale proceeds are $20,000 (400 shares × $50). Under Reg T, the investor deposits the greater of 50% or $2,000. Here, 50% is $10,000, so that’s the deposit. The credit balance is the short sale proceeds plus the deposit: $20,000 + $10,000 = $30,000.

Now update the equity formula after the stock falls to $35:

$30,000 (credit) - $14,000 (SMV) = $16,000 (equity)

SMV falls to $14,000 (400 shares × $35). The credit balance doesn’t change because the investor hasn’t sold short more shares or bought shares to cover. Equity rises to $16,000.

Equity percentage:

Equity % = $16,000 (equity) / $14,000 (SMV) Equity % = 114.3%

(With short accounts, equity percentage can exceed 100%.)

Now compute excess equity (equity above 50%):

$$\text{Excess equity}=\text{equity - 50\% of SMV}$$

Excess equity = $16,000 (equity) - $7,000 (50% of SMV)

Excess equity = $9,000

In most cases, excess equity and SMA are the same. Here, SMA is $9,000.

An SMA of $9,000 in a short account allows the investor to:

• Sell short $18,000 of new stock without depositing any new money
• Withdraw $9,000 of cash from the account for any purpose

Because selling power = 2 × SMA, the selling power is $18,000.

Re-state the account before using SMA:

$30,000 (credit) - $14,000 (SMV) = $16,000 (equity)

SMA = $9,000

Now, assume the investor uses all their SMA to sell short $18,000 of new stock without making a new deposit. What happens to the equity formula?

Can you figure it out?

The investor can also withdraw SMA as cash.

Re-state the account before withdrawing SMA:

$30,000 (credit) - $14,000 (SMV) = $16,000 (equity)

SMA = $9,000

An SMA level of $9,000 allows the investor to withdraw up to $9,000 from their account for any purpose. If this occurs, what happens to the equity?

SMA in a short account also acts like a credit line. As the short position becomes less expensive (SMV falls), SMA is created. You can calculate it using excess equity, or use this shortcut:

For every $1 the SMV decreases, the SMA increases by $1.50.

Now try one on your own.

An investor sells short 200 shares of stock at $60 per share in their margin account and makes the required Reg T deposit. The market price falls to $40 per share. Answer these questions:

What is the equity (in $ and %)?

What is the excess equity / SMA?

What is the buying power?

How much may they withdraw in cash?

How far can you get?

As with long accounts, SMA is a “high water mark” in short accounts. SMA is created as SMV falls, and it isn’t lost if SMV later rises. SMA is only reduced when it’s used (by selling short using selling power or by withdrawing SMA as cash). Investors can use SMA unless doing so would push equity below minimum maintenance (30%).

Key points

Special memorandum account (SMA)

• Like a credit line in a margin account
• Allows additional funds to be borrowed
• Can be withdrawn as cash

Excess equity

• Equity - 50% LMV or SMV
• Amount of equity above 50%
• Typically equal to SMA

SMA in long accounts

• Increases if LMV rises
• $1 LMV increase = $0.50 SMA increase
• SMA is not lost if the market declines
• 2x SMA = buying power

SMA in short accounts

• Increases if SMV falls
• $1 SMV decrease = $1.50 SMA increase
• SMA is not lost if the market increases
• 2x SMA = selling power