---
description: "Background on index investing: an index is a diversified portfolio of assets with defined weights, and investment vehicles such as futures and ETFs allow efficient, single-trade exposure to broad indexes."
tags: [indexes, background, etf, futures, index-arbitrage]
---

# Index Generalities

**Section**: 6.1 | **Asset Class**: Indexes | **Type**: Background / Reference

## Overview
An index is a diversified portfolio of assets combined according to specified weights. The underlying assets are typically stocks (e.g., DJIA, S&P 500, Russell 3000). Index weights are determined by price (DJIA) or market capitalization (S&P 500, Russell 3000). Investment vehicles such as index futures and index-based ETFs allow a trader to gain broad market exposure through a single trade.

## Construction / Mechanics

**Index types by weighting scheme**:
- **Price-weighted**: DJIA — each stock's weight proportional to its price; a high-priced stock has disproportionate influence.
- **Market-cap-weighted**: S&P 500, Russell 3000 — each stock's weight proportional to its market capitalization (shares × price); larger companies dominate.
- **Equal-weighted**: each constituent receives the same weight; requires frequent rebalancing.

**Investment vehicles**:
- **Index futures**: standardized contracts to buy/sell the index at a future date; require no upfront payment of the full notional (margin only); settled in cash.
- **Index ETFs**: exchange-traded funds that hold (or replicate) the index constituents; trade intraday like stocks; e.g., SPY (S&P 500), IVV (iShares S&P 500).
- Both instruments allow leveraged or hedged exposure to the index.

## Key Concepts
- **Spot price S(t)**: current value of the index based on constituent prices.
- **Futures price F(t,T)**: price of the futures contract with delivery at T; theoretically F*(t,T) = [S(t) - D(t,T)] · exp(r(T-t)) where D(t,T) is the present value of dividends and r is the risk-free rate.
- **Basis B(t,T)**: normalized difference between futures price and theoretical fair value; basis trading exploits deviations of B from zero.
- **Tracking error**: difference between an ETF's NAV return and the index return; minimizing tracking error is a key ETF management objective.

## Notes
- Index futures and ETFs are highly liquid, making index strategies generally easier to implement than single-stock strategies.
- Market-cap-weighted indexes concentrate exposure in the largest stocks; this can create significant single-name risk.
- ETF arbitrage (Section 6.4) exploits intraday mispricings between different ETFs tracking the same index.
- Dispersion trading (Section 6.3) exploits the difference between index implied volatility and constituent implied volatilities.