Overview of the S&P 500 Index

The Standard and Poor’s 500 (or more commonly known as the S&P 500) is a stock market index made up of 500 leading companies publicly traded in the U.S. stock market.

The companies are selected by Standard and Poor’s Index Committee and the index is designed to be a leading indicator of the US equities market.

Many people agree that the S&P500 index is a better representation of the US market as it contains 500 large, blue-chip companies compared to the Dow Jones’ 30.

Companies in the S&P 500 Index

The S&P 500 contains all of the stocks in the Dow Jones with an additional 470. Some notable stocks in this additional 470 include:

Apple Inc. Oracle Corp. Bank of America Corp.
Google Inc. QUALCOMM Inc. Berkshire Hathaway Inc.
Wells Fargo and Co. Citigroup Inc Kraft Foods Inc.
Microsoft Corp. PepsiCo Inc. Comcast Corp.

Google and Apple, who do not feature in the Dow Jones due to their large stock prices, are key components of the S&P500. They are heavily weighted but due to the size of the S&P, they do not dominate it like they would the Dow. The S&P is made up of companies from a wide array of industry sectors. Below we see the weightings of each sector (accurate as of August 2013):

Sector Weight (%)
Technology 17.73
Financial Services 16.71
Health Care 12.97
Customer Discretionary 12.18
Energy 10.51
Consumer Staples 10.41
Industrials 10.28
Materials 3.32
Utilities 3.30
Telecommunications 2.58

 

Admission to the S&P 500 Index

A company will be considered for admission to the S&P500 when its market capitalization is within the top 500 in the US. In addition to this the S&P admissions board will consider several other criteria:

  • Minimum market capitalization of $4 billion
  • Sufficient amount of shares in public hands
  • Liquidity – minimum trading volume of 250,000 shares each month before evaluation
  • Correct sector classification
  • Listed on NYSE or NASDAQ exchange
  • Sufficient length of time on this exchange
  • Financial viability of the firm When a company is added to the S&P we usually see the share price of that company rise as managers of index funds will normally purchase that company’s stock in order to continue tracking the S&P500.

Weighting of the S&P500

The weighting method used by the S&P500 differs from the Dow in that it weighs companies according to their overall market capitalization. Market capitalization, therefore, gives a better gauge of the overall size and value of a company rather than just taking the price of each share. The S&P500’s capitalization-weighted method is also float-weighted which means that it only takes into account the number of shares available for public trading between institutional and retail investors. It therefore excludes any shares that are tied up in the company itself or any government holdings.

Calculation of the S&P 500 Index

Just like the Dow Jones the S&P500 is calculated using a divisor set by Standard and Poor’s. The calculation of the index adds all market capitalizations for each of the 500 companies and divides the sum by this divisor. So for example, if the market cap of the 500 stocks came to $13 trillion and the divisor is set at 8.9 billion we would have an S&P index value of 1,460.67. This divisor is adjusted in the case of stock issuance, mergers, change of companies in the index amongst other corporate actions to ensure that such events do not significantly alter the value of the index. However, unlike the Dow Jones, it does not adjust its divisor on the back of a stock split because the market capitalization of the company will remain the same.

The Value of the S&P 500

Just like the Dow Jones, the S&P hit an intra-day high of 1,552.87 in March 2000 at the height of the dot-com bubble. We then saw it decline drastically by over 50% to 768.63 during the stock market downturn of 2001/2002 due to the dot-com bubble bursting along with political and social adversities such as 9/11 and the Afghan and Iraq Wars.

During the boom of the mid 2000s we saw the S&P soar once more and it hit a new record high with a close of 1,565.15 on October 9th 2007. The market began to decline from this peak on the back of the financial crisis. It hit its lowest point in 13 years on 9th March 2009 closing at 676.53.

In 2013 we have seen the S&P500 rise by more than 25% on the back of QE3 – the Federal Reserve’s third round of quantitative easing which sees $85bn a month being printed to buy mortgage-backed securities and treasury bonds. This monetary policy has seen stock prices rise drastically in value.

On September 19th 2013 we saw the index hit its all-time record high closing the day at 1,725.52.

Recent Historical Performance of the S&P 500 Index

Below is a chart of the S&P 500 from mid-2008 to the start of October 2013. In the above chart, we have outlined the effect that monetary policy has had on the S&P 500.

QE1: November 2008 – March 2010 The first round of quantitative easing (QE1) to help stimulate the economy and promote lending was announced at the end of 2008. Ben Bernanke, the Chairman of the Federal Reserve announced that the Fed would purchase $600 billion in mortgage-backed securities and agency debt. This was then expanded on March 18th, 2009 and we saw an immediate impact on the markets. The S&P soared over 500 points from just under 700 to over 1200.

QE2: November 2010 – June 2011 On November 3rd 2010 Bernanke announced a second round of quantitative easing to further stimulate the economy. The Fed would purchase $600 billion of longer-dated treasuries, at a rate of $75 billion per month. The market had already reacted to this news as Bernanke strongly hinted towards the policy a few months before the official announcement. Again we saw the S&P rise over 300 points from 1050 to over 1350.

Operation Twist: 2011 The Fed announced on 21st September the implementation of Operation Twist. This was a plan to purchase $400 billion of bonds with maturities of 6 to 30 years and to sell bonds with maturities less than 3 years. This was an attempt to do what quantitative easing tries to do, without printing more money and without expanding the Fed’s balance sheet. This led to a strengthening US dollar rather than a weakening one like QE does. The implementation also had a positive impact on the stock markets and we saw the S&P rise from 1100 to 1450 throughout 2012.

QE3: September 2012 – Present* On September 13th 2012, the Fed announced a third round of quantitative easing and is still in effect to present (*October 1st 2013). The unemployment rate of the US is the key concern and the Fed have made an open-ended commitment to purchase $40bn worth of mortgage-backed securities and $45bn worth of long-term treasury bonds until the labor market improves ‘substantially’. As a result of QE3 we have seen the S&P rise substantially in 2013 hitting its all-time high on 19th September 2013. It is likely we will see a tapering of QE3 before the end of 2013.

Things to Remember When Trading the S&P Index

  • The S&P futures contract (called the E-Mini) is tradable from 22:01 – 20:14 (GMT), Monday to Friday.
  • The S&P moves in increments of 0.25.
  • The margin requirement for trading the S&P is usually about 0.5% (i.e. 200 to 1 leverage) with most brokers.
  • The minimum trade size is 1 index.
  • The currency of the S&P is the US Dollar.

Trade Example

So let’s say we want to BUY 1 index of the S&P500 and it is currently priced at 1,600 and we have a US Dollar denominated trading account:

The margin (or funds) we would need to put up to open this position would be just $8.00. ($1,600 (price of S&P) X 0.5% (margin requirement) = $8.00)

This amount can be seen in the ‘used margin’ section on our trading platform.

If we have an account in a different base currency such as Euro, our margin remains 0.5% but our trading platform will automatically convert the $8 to Euro.

So say the EUR/USD rate is 1.3500. We then see approximately €5.90 in the ‘used margin’ section of our Euro account.

Every move in the S&P500 is 0.25 cent (dollar), so in our example, if we bought 1 index and the S&P rises from 1,600.00 to 1,625.25 we make a profit of $25.25  (or €18.70 at our exchange rate above.