- 2000: Volume 9, No. 6 Ask Dr. Index: Indexes, Schmindexes

What's in a name? Or a number, for that matter? Confusion sets in, it seems, when index providers slap different tail numbers on their indexes. A peek into the doctor's mailbag found some people wondering about the differences.

Dr. Index,

What's the difference between the S&P 500 (SPX) and the S&P 100 (OEX)? Aside from telling me "There are 500 stocks in one; only 100 in the other," most folks I ask seemed as befuddled as me. The indexes are priced differently. What implications are there for products based on these indexes?

The numbers ARE the big difference. Aside from that, however, they're mighty similar.

OEX actually got its start in 1983 as a creation of the Chicago Board Options Exchange (OEX: Options Exchange, get it?). The index originally represented the top 100 stocks underlying CBOE-listed options. But Standard & Poor's now manages the index. To no one's surprise, there's always been good correlation between OEX and SPX. Back in earlier days, option trading was based ONLY on blue-chip stocks. The S&P 500 Index was a perfect list from which options exchanges could "shop" for new listings-finding underlying stocks with the requisite liquidity to support then-nascent options trading.

In early October, SPX hovered about 1400; OEX around 740. Contrary to a commonly-held notion, OEX's original price wasn't carved out of SPX's. SPX started at 10, reflecting component prices for the 1941-1943 base period. OEX, while launched in 1983, was priced at 50 as of January 1976. The index later split 2-for-1 in November 1997.

The correlation between OEX and SPX has been 99.40 percent over the past five years. This tight fit is due mainly to an overlap in the index's market capitalization-weighted stock lists (see Table 1).

Table 1

Top 4 Components (By weight in index)
	OEX (S&P 100 Index)	SPX (S&P 500 Index)
General Electric Cisco Systems, Inc. Exxon Mobil Corp. Microsoft Corp.	9.04% 5.90% 5.13% 4.52%	4.69% 3.07% 2.66% 2.35%
Top 4 Total Weight	24.92%	12.77%

Because the indexes are highly correlated isn't to say that returns don't vary, however. The average annual return for OEX has been 21.86 percent over the past five years, while SPX's has been 19.22 percent. It's really the similarity in the direction and degree of index price movements that accounts for the correlation. Generally speaking, when SPX goes up, so too, does OEX. Both indexes tend to fall simultaneously as well.

But with the bigger average annual gain exhibited by OEX over the past few years, it's easy to assume OEX is more volatile than SPX. That may be true, but the difference may not be as large as many believe. As of early October, 100-day volatility for OEX was 16.93 percent; SPX's stood at 15.83 percent. So, what do these numbers mean? Simply this: based upon the past 100 trading days, OEX behaves as if there's a two-thirds probability the index will end up within about 17 percent (plus or minus) of its average price in 12 months. SPX acts like it will end up within 16 percent. These numbers, remember, are backward-looking, and are not guarantees of future volatility.

For us statistically-minded nebbishes, a stricter metric of correlation is r2, which has been 96.70 percent from January through October. Basically, r2 boils the relationship down to this: how much of OEX's price movements can be "explained" by movements in SPX? As you can see, the answer is "a lot."

Bottom line? OEX is a pretty good proxy for SPX. If you can't use S&P 500-based products, using those based on the S&P 100 are likely to keep you in the same ballpark.

Dr. Index,

I've seen funds and derivatives based upon the Russell 1000 and the Russell 2000 indexes. I've heard, too, about a Russell 3000 index. Do the numbers refer to the number of stocks in the indexes?

Maybe. And that's not cute journalistic dodge, either. The indexes may start with baskets of those sizes, but they may not stay that way. It has to do with Russell's annual reconstitution and maintenance methodology.

Frank Russell Company compiles nearly two dozen U.S. equity indexes. The "parent" for all its indexes is the Russell 3000. Russell reconstitutes the index annually to include the 3,000 largest-capitalized U.S. companies. Russell claims the index represents approximately 98 percent of the investable U.S. equity market. As of the latest reconstitution, its average component market capitalization was $5.1 billion; the median market capitalization was $791.1 million.

Once the 3,000 names are set, Russell takes the 1,000 largest-capitalized issues as the Russell 1000. The remaining issues are used to populate the Russell 2000 index.

The Russell 1000 is typically thought to be a large capitalization index, representing approximately 92 percent of the total market capitalization of the Russell 3000 index, or about 90 percent of the total investable U.S. equity. At the last reconstitution, the index's average component market capitalization was $14.1 billion; the median market capitalization was $4.1 billion.

The remaining eight percent of the total market capitalization of the Russell 3000 (about eight percent of total investable U.S. equity as well), comprises the Russell 2000 index. The Russell 2000 is generally considered as a small capitalization index. As of the latest reconstitution, its average component market capitalization was $580 million; the median market capitalization was $466 million.

Once we get beyond the June 30 annual reconstitution date, names can start dropping out of the indexes. Corporate actions like mergers and acquisitions can make the baskets look like they're withering, since Russell's index maintenance rules don't permit replacement of deleted stocks. The only additions permitted between reconstitution dates are spin-offs.

So, as I pen this in October, I'm wondering ...

Should we recast these benchmarks as the Russell 2920, the Russell 1943, and the Russell 977? Those names just roll off your tongue, don't they?

Brad Zigler is head of investor education at Barclays Global Investors Services. Questions can be directed to Dr. Index at http://www.ishares.com/dr_index/.