What is the S&P 500 and How to Trade ETFs on the Index

What is the S&P 500 and How to Trade ETFs on the Index

Stock Index S&P 500

The index, consisting of 500 stocks from Standard & Poor's (abbreviated as S&P 500), is one of the most popular stock indices in the world, representing 500 significant public organizations in the USA. In the Russian-speaking segment, it is called СНП 500. Due to its scale and the method of calculation based on market capitalization of stocks, the index is the most reliable indicator of the development of the US stock market. In addition to its primary function of being a market benchmark, it is also used for speculation on price movements.

15-Year Chart of the S&P 500 Index

History of the Creation of S&P 500

The index was created by Standard & Poor's, a financial market analysis company, in 1923 when the "Composite Index" was created. This predecessor of today's S&P initially included just a few dozen companies. When, in 1941, the publishing and standard statistics Poor's merged, the index of the new corporation was renamed to S&P 90. Gradually, stocks were added, and on March 4, 1957, the number of stocks reached its final value of 500.

Today, the S&P index covers about 80% of the stocks on the US stock market, while the older and more famous Dow covers only a quarter.

Economic Sectors of the USA Represented in the Index

• Consumer Discretionary (XLY) – consumer goods.
• Consumer Staples (XLP) – everyday goods.
• (XLE) Energy – energy.
• (XLF) Financials – finance.
• (XLV) Health Care – pharmaceuticals.
• (XLI) Industrials – industry.
• Materials (XLB) – basic materials.
• Real Estate (XLRE) – real estate.
• Technology (XLK) – technology.
• Utilities (XLU) – utilities.

How the Index Value is Calculated

The S&P 500 is calculated based on floating market capitalization. This means that we multiply the price of one share by the total number of publicly traded shares. The resulting value is then divided by a divisor. The value of the divisor is determined and changed by the owner of the index as needed. The purpose of the divisor in the S&P 500 is to maintain price consistency. Companies often split their shares or remove shares from circulation, merge into conglomerates, create smaller subsidiaries, etc. The divisor ensures that, despite these structural changes, the price of the S&P 500 remains consistent.

Conditions for Adding Companies to the Index

As with the Dow Jones index, inclusion or exclusion of corporations is determined not only by fixed rules but also by subjective factors. Here is a list of objective criteria for inclusion in the index:

• The total value of the company’s shares must be at least $8.2 billion.
• Publicly traded shares must outweigh "blocked" shares, i.e., non-traded shares owned by, for example, company founders, managers, other firms, the government, etc.
• The minimum monthly trading volume must be 250,000 shares traded in each of the previous 6 months before inclusion in the index.

Stages of ETF Creation

In 1993, the first-ever ETF was created – the Standard & Poor's Depositary Receipts (SPDR), colloquially known as the “Spider”. This ETF, managed by SSGA (State Street Global Advisors), tracks one-tenth of the value of the S&P 500 index. Gradually, a series of other ETFs were created for the S&P 500 and global indices.

Advantages and Disadvantages of Trading ETFs on the S&P 500 Index

Arguments "For":

• Trading ETFs offers wide diversification opportunities. An investor buying an ETF does not risk individual assets but instead owns a basket of stocks.
• ETF trading has very low fees, which significantly saves the trader's funds.
• Small deposits can be used for ETF trading, and the market entry threshold is low.
• ETFs on the S&P 500 index have very high liquidity, allowing the implementation of any strategy.
• The transparency of information about ETFs makes this asset safe.

Arguments "Against":

• Tracking errors may occur, which may be present when copying the underlying asset.
• There are commission fees for the broker on transactions when purchasing ETFs.

How to Trade ETFs on the S&P 500 Index

ETFs on the S&P 500 index are derivative instruments, so all basic risk-management principles apply to them. Beginners are advised to test their strategy on a demo account. Experienced traders can use any of the offered platforms: RT, Alpha Trader, Sterling Trader Pro, Lightspeed. All platforms feature online charts and full functionality for purchasing ETFs on the S&P 500 index.