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Play the index market is through a relatively new investment vehicle, exchange-traded funds (ETFs)Index Markets As noted earlier, an index is a tool used to measure and report value changes in a specific group of stocks or commodities. There is a variety of indexes tailored to reflect the performances of many different markets or sectors. Here are some of the most popular market indexes (also known as averages or market averages): Dow Jones Industrial Average ($INDU). The most widely followed index, the DJIA represents 30 blue-chip stocks and is used as an overall indicator of market performance. Standard & Poors 500 Index ($SPX). A benchmark of U.S. common stock performance, this index includes 500 of the largest U.S. stocks400 industrial companies, 40 utilities, 40 financial corporations, and 20 transportation companies. NYSE Composite Index. This index is composed of all the stocks traded on the New York Stock Exchange. Nasdaq Composite Index ($COMPQ). This index tracks the perfor mances of all stocks traded on the Nasdaq Stock Market. The National Association of Securities Dealers Automated Quotations (NASDAQ) devised a computerized system that provides brokers and dealers with price quotations for securities traded over-the-counter as well as for many New York Stock Exchange-listed securities. Nasdaq 100 Index ($NDX). The top 100 nonfinancial stocks trading on the Nasdaq Stock Market. S&P 100 Index ($OEX). This index represents 100 of the largest U.S.stocks with listed options. Wilshire 5000. This market value-weighted index monitors 7,000 U.S.-based equities traded on the New York Stock Exchange, the American Stock Exchange, and the Nasdaq Stock Market, and is a popular indicator of the broad trend in stock prices. Commodity Research Bureau Futures Price Index (CRB Futures). This index tracks the commodity markets and is closely monitored as an indicator of economic inflation. DAX. Similar to the U.S. Dow Jones Industrial Average, this index tracks the performance of the top 30 German stocks. This is not a market capitalization-weighted index; each company has an equal weighting. Financial Times Stock Exchange (FTSE) Index. This index is com posed of the top 100 companies (by market capitalization) in Great Britain. Euro Stoxx 50. This index tracks the top 50 stocks from the EuropeanEconomic Community. Nikkei 225. This benchmark index is composed of 225 Japanese com panies and is a popular indicator of the broad trend in stock prices. As you can see from the wide variety of indexes listed, you can trade in virtually any type of market that interests you. Indexes like the ones listed can help to track and monitor changes not just in the U.S. market, but around the globe. However, it is important to specialize in just one index to begin with and then continue learning various risk management techniques. There is a vast amount of information that everyone needs to sort out, and thats what makes investing so interesting. It is exciting to find the needle in the haystackyou just need to know where to begin looking and what to look for. Buying (going long) and selling (going short) are the simplest forms of trading in futures markets. They are also the most popular strategies because many individuals are not familiar with the more creative aspects of trading. However, by learning to combine stocks with options, you can create trades that limit risk and maximize your potential profits. Exchange-Traded Funds Another way to play the index market is through a relatively new investment vehicle, exchange-traded funds (ETFs). Despite their relative newness, ETFs have become among the most popular trading tools in the marketplace today. For example, you have probably heard of the Nasdaq 100 QQQ Index (QQQ). Not only is it the most actively traded exchange-traded fund today, it has one of the busiest options contracts. In addition, there are a host of different ETFs available to the option strategist today. Consequently, understanding what these investment vehicles are and how they trade can open up an enormous number of trading opportunities. The American Stock Exchange pioneered the concept of ETFs when the exchange launched the S&P Depositary Receipts (SPY), or Spiders, in 1993. In a nutshell, ETFs trade like stocks, but represent specific indexes. Therefore, exchange-traded funds offer investors a way to buy and sell shares that represent entire baskets of stocks. In the case of Spiders, the basket of stocks represents the companies included within the Standard & Poors 500 Index. When buying SPY shares, investors are really buying the entire S&P 500 Index. Dow Jones Diamonds (DIA), in turn, track the performance of the Dow Jones Industrial Average ($INDU) and started trading in 1998. The QQQ, also known as the Qs, is todays most popular exchange-traded fund and made its debut in March 1999. It tracks the performance of the Nasdaq 100 ($NDX). While QQQ options have been actively traded for several years, options on DIA made their debut earlier this year and there are no options yet available on the SPY. The American Stock Exchange, however, has not been the sole player in the ETF market. Barclays Global Investors introduced a series of ETFs in June 1996 called WEBs (now known as iShares). To date, the company has brought forth more than 60 of these so-called iShares, which trade on the American Stock Exchange. Holding Company Depositary Receipts (HOLDRS) are another type of exchange-traded fund. HOLDRS also trade on the American Stock Exchange and can be bought and sold in round lots of 100 shares. In addition, HOLDRS are available on a variety of different industry groups such oil service, biotechnology, semiconductors, and so on. Not all iShares and HOLDRS have options linked to their performance, however. In order to find those that do, option traders can visit the Chicago Board Options Exchange (www.cboe.com) and the American Stock Exchange (www.amex.com), where complete product specifications are available for HOLDRS and iShares. The Nasdaq Stock Market also has plans to list its own family of exchange-traded funds. The exchanges list of ETFs will include the first-ever fund based on the performance of the widely watched Nasdaq Composite Index ($COMPQ). In addition, the family of exchange-traded funds is expected to include companies that trade on the Nasdaq from specific industries such as telecommunications, financial services, biotechnology, and so on. Furthermore, these investment vehicles will trade on the Nasdaq Stock Market. The launch of the new Nasdaq ETFs is expected to occur later this year. While there are a number of different ETFs available for trading today, there is an important distinction between these investment vehicles and the more common cash-based index products. In fact, indexes and index options date back well before the development of exchange-traded funds. Charles Dow created the first index in 1884. It was known as the Dow Jones Railroad Average (todays Dow Jones Transportation Average [$TRAN]). Index options did not come into existence until almost a century later. To be specific, the Chicago Board Options Exchange (CBOE) was the first to list options on the S&P 100 Index ($OEX) in 1983. Since that time, options have been launched on a number of other indexes. Some, like the OEX, reflect the performance of the entire market. For instance, traders can buy and sell options on the S&P 500 Index ($SPX) and the Dow Jones Industrial Average ($DJX). These, of course, are familiar measures of the U.S. stock market. Other indexes are designed to gauge the performance of specific sectors. These include the PHLX Semiconductor Index ($SOX), the AMEX Biotechnology Index ($BTK), and the Morgan Stanley Oil Service Index ($MGO). There are a large number of other cash-based indexes and their complete specifications can be found on the web sites of the Chicago Board Options Exchange, the American Stock Exchange, or the Philadelphia Stock Exchange (www.phlx.com). There is an important difference between ETFs like the Nasdaq 100 QQQ and cash-based indexes. Specifically, exchange-traded funds are physical delivery options (i.e., settle for shares), but index options involve cash settlement. For instance, a call writer (seller) who is faced with assignment on his or her Diamonds must deliver DIA shares. However, a call writer of DJX options must provide cash payment (equal to the difference between the exercise settlement value and the strike price of the index option). In addition, most index options settle European-style and, therefore, exercise can only take place at expiration. By contrast, ETFs settle American-style, which means that option writers can face assignment at any time prior to expiration. |
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