Spiders: Where Are the Bugs?

One of the clearest trends in asset management is the rapid increase in the amount of individual and institutional money invested in indexed products. By far the most popular index which investors want to replicate is the S&P 500 index. While many academic studies have examined the characteristics of two instruments frequently used to replicate the S&P, index funds and futures, very little has been written about the newest way to replicate the S&P 500 index: Standard and Poors Depository Receipts (SDPR) commonly referred to as Spiders. The importance of Spiders can be seen by the fact that at the end of 1999 there were 19.8 billion dollars invested in Spiders and that in 1998 daily shares traded in Spiders exceeded any other stock except Compaq and daily dollar volume was the highest of any share traded. This is all the more surprising given the fact that Spiders have not been around very long.
There are three major reasons why this analysis is useful. First, the principal advantage of Spiders versus index funds is that they can be purchased and sold at prices which exist at any time during the trading day. As we will show, low-cost index funds produce higher returns than Spiders. Given that investors can use either vehicle, the difference in return gives a measure of the value of immediacy. The value of immediacy is an important issue in the literature on market microstructure. Second, since Spiders have become an important investment vehicle in terms of both trading volume and dollar value outstanding, their performance and characteristics are of interest by themselves. Third, the organizational form of Spiders is seen
as the prototype for index funds of the future, and thus it is important to understand both their performance and the affect of the organizational structure on that performance.
Before analyzing Spiders, we will briefly review their history and important characteristics. Each Spider represents an ownership interest in the SPDR Trust. The Trust as stated in the prospectus holds all of the common stocks in the S&P 500 composite stock price index and is intended to provide investment results that, before expenses, generally correspond to the price and yield performance of the S&P 500 Index. Spiders are traded on the American Stock Exchange and can be bought and sold like any stock at any time during the day. One Spider has a price equal to approximately 1/10 of the price of the S&P Index. The initial deposit creating Spiders was made on January 22, 1993. The Spider was organized as an investment trust and has a mandatory termination date of January 22, 22183. Any trust is governed by a trust agreement and there are certain aspects of the trust agreement governing Spiders which are important to understand. First, Spiders charge an expense ratio to holders of the Spider. This has historically been 18.45 basis points per annum. Second, a specific mechanism exists
for changing the number of Spiders outstanding. Investors can create or delete Spiders in minimum units of 50,000 shares by engaging in transactions in kind plus getting or receiving certain sums of cash. For example, investors can turn in a bundle of stock matching the S&P Index plus cash equal to the accumulated dividends less management expenses and receive Spiders in return. Investors can do so for a payment of $3,000 (regardless of the size of the transaction).
There is another peculiar aspect of Spiders that arises from their organizational form. Spiders pay out the dividends the trust receives on the stocks that it holds quarterly; on the last business days of April, July, October and January (though the ex-dividend day of the trust occurs in the previous month). What is unusual is that the dividends the trust receives from the
underlying stock is held in a non-earning account between the time it is received and the time it is paid out.
Having provided background on Spiders, we turn to the purpose of this article: to study the performance of Spiders and to compare Spiders with other methods of indexing. This paper proceeds as follows: In the first section we examine the performance of Spiders as an investment vehicle. We start by examining the return from holding Spiders compared with the return from holding the S&P Index. In this section we first examine Spider returns as if Spiders could be bought and sold at their net asset value. We then examine the magnitude and time path of the differences between Spider price and NAV. Since Spiders are not the only way of holding an index, we next compare the return on Spiders with the return on other methods of indexing, index funds and futures. One of the unique aspects of Spiders is the ability of investors to create and delete them by turning in or receiving bundles of securities.

Read More..

THE SINGLE CURRENCY

In January 2002, euro notes and coins were actually being circulated in the different countries and by the end of the first quarter, national notes and coins no longer existed. This change had an impact on everyone, from manufacturers, importers and exporters with trade flows to hedge, central banks with reserve asset and debt management concerns, to financial institutions and pension funds with international portfolios. In fact, even though this event was specific to Europe, the impact affected the world’s currency market community from American to Japan. The single currency in Europe formed one corner of the new triangular world of the dollar, the yen and the euro.
The conversion of national legacy currencies meant that organisations had to have the ability to accept both forms of transaction. It has been quite complicated because, for instance, to convert sterling to francs you had to have a conversion via the euro. This is because the national legacy currency no longer existed in its own right but was a denomination of the euro, fixed by the conversion rate. The European currencies have always fluctuated against the dollar, even as the debate about the euro raged. This can be shown by:
Birth of European Monetary System – it was the economic crisis of the 1970s that led to the first plans for a single currency. The system of fixed exchange rates pegged to the dollar was abandoned. European leaders agreed to create a “currency snake”, tying together European currencies. However, the system immediately came under pressure from the dollar, causing problems for some of the weaker European currencies.
Kuwait crisis – on 2 August 1990 Iraq invaded Kuwait. On the same day, the UN Security Council passed a resolution condemning the invasion.
Maastricht Treaty – in 1991, the 15 members of the European Union, meeting in the Dutch town of Maastricht, agreed to set up a single currency as part of a drive towards economic and monetary union. There were strict criteria for joining, including targets for inflation, interest rates and budget deficits. A European Central Bank was established to set interest rates. Britain
and Denmark, however, opted out of these plans.
ERM crisis – the exchange rate mechanism was established in 1979 and was used to keep the value of European currencies stable. However, fears that voters might reject the Maastricht Treaty led currency speculators to target the weaker currencies. In September 1992, Britain and a few of the other EU countries were forced to devalue. Only the French franc was successfully defended against the speculators.
Asian crisis – the turbulence in the Asian currency markets began in July 1997 in Thailand and quickly spread throughout the Asian economies, eventually reaching Russia and Brazil. Foreign lenders withdrew their funds amid fears of a global financial meltdown and the dollar strengthened. ManyEUcountries were struggling to cut their budget deficits to meet the criteria
for euro membership.
Euro launch – the euro, of course, was launched on 1 January 1999 as an electronic currency used by banks, foreign exchange dealers and stock markets. The new European Central Bank set interest rates across the euro zone. However, uncertainty about its policy and public disagreements among member governments weakened the value of the euro on the foreign exchange markets.

Central bank intervention – after just 20 months, the euro had lost nearly 30% in value against the dollar. The European Central Bank and other central banks finally joined forces to boost its value. The move helped put a floor under the euro, but it has still not recovered its value. A weak euro has helped European exports, but it has also undermined the credibility of the currency and has fuelled inflationary pressures.

Terrorist attack on New York and Washington – this attack in New York severely tested the currency markets. Money flowed out of the dollar into safe havens like the Swiss franc and, for the first time, into the euro. The central banks tried to calm the markets and interest rates were cut across the globe. Many observers believe it may have marked the coming of age of the euro as an international currency.
Euro becomes cash currency – on 1 January 2002, the euro became a reality for approximately
300 million citizens of the 12 countries in the euro zone. The arrival of the euro as a cash currency may foster closer integration and greater price competition within the euro zone. It may also help boost its international role, as doubts grow over the strength of the dollar, especially as American economy continues to slow.

Read More..

Short-Term Reversal Systems

Reversal systems are among the most effective systems that you can find for trading the stock index futures contracts. One of the most pronounced tendencies of the stock market is for the indices such as the S&P 500 to travel from a relative low to a relative high and from a relative high to a relative low. By this we mean that the market will often swing from the lowest close in x number of days to the highest closing price in x number of days.
The focus of my reversal system is a short-term move that reverses a recent extreme in price. You await the onset of a reversal from a relative high or low before trading in the direction of this counter-swing. The historical results of our system are high enough to warrant the use of such vehicles as OEX put and call options. We do not recommend futures positions leveraged far .beyond your cash. Rather, the safety net provided by slightly out of the money hedging options against futures positions can be crucial to your survival when the unexpected strikes.
In the S&P 500 futures market, many traders employ stochastics, RSI and other trading oscillators. Normally these traders will buy at the close when the oscillators move from oversold to overbought and sell when the reverse occurs. I refer you to my chapter on the "Market Wizard" method for more detail on this type of strategy. The prevalence of oscillator trading strategies can provide an edge in using intraday reversal systems. Indeed, I will show you how oscillator traders will actually push our reversal system trades in the direction we want.

Read More..

THE IMPORTANCE OF TIMING

A few thoughts about timing are important before we move forward. We would like to think that we can profit from the news if we act faster than others. It’s not true.

• The market moves on anticipation. “Buy the rumor, sell the fact.” If you bought on every piece of good news published in the Wall Street Journal, you would be broke.
• The market responds to the difference between the actual news and what was expected. The unemployment rate could have dropped 0.2 percent, and the market falls because it expected a drop of 0.4 percent.
• Action does not always mean immediate reaction. When did the Fed start lowering interest rates? When did the market start to respond? In the case of interest rates, it always takes more than one move by the Fed before you see a reaction in the economy.

Can You Apply the Same Buy-Sell Principles to All Stocks?

• Can you write down the rules you’ve used to buy and sell a stock, any stock? Can you write down the rules for when you would have exited the long positions in the previous stock charts? If so, you’re a systematic trader.
• When you look at a chart, do you see it in terms of continuous price moves? Do you look at the highs and lows of price swings? Do you draw conclusions, make up rules, and imagine that you can capture large profits?
  

Looking at a historic chart is frustrating and deceiving. It makes you think that you could have profited from the price moves. It’s much harder when you can’t see the future. However, high-tech display equipment lets you see the past price movement of any stock. It has brought many new traders to the table who think they can profit from future price moves because they can see the past.

Read More..