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FAQ: Cboe S&P 500 Dispersion Index

An Overview of Return Types for Insurance Indices

A Closer Look at the SAR Government Sukuk Market

Reflecting on 25 Years of the S&P/TSX Index Series and Its Impact on the Canadian Investment Industry

TalkingPoints: The S&P 500® Sector-Neutral FCF Index — Why Free Cash Flow is King

FAQ: Cboe S&P 500 Dispersion Index

1. What is the Cboe S&P 500 Dispersion Index (DSPX)?  The Cboe S&P 500 Dispersion Index, also referred to as the Dispersion Index or DSPX, is an index that seeks to measure the expected dispersion in the S&P 500 over the next 30 calendar days, as calculated from the prices of S&P 500 index options and the prices of single-stock options of selected S&P 500 constituents, using a modified version of the VIX® methodology.

The index level reflects an annualized statistic. For example, an index level of 20 corresponds to an expectation for a standard deviation of 20% among the annualized returns of S&P 500 constituents over the next 30 days.

The index level is calculated every 15 seconds from 9:45 a.m. to 4:00 p.m. New York time during standard equity trading days.

2. What is dispersion?  Dispersion is a fundamental measure of risk and opportunity in the stock market. It measures how differently stocks are performing or are expected to perform.

Like volatility and VIX, we may measure dispersion historically or derive an expectation-based measure from the options market. DSPX is an expectation-based measure.

3. What does DSPX measure?  The index measures market expectations for dispersion by comparing the prices of S&P 500 constituent stock options and S&P 500 index options with maturities around 30 calendar days.

A complementary measure to market volatility—which measures overall fluctuations in stock averages like the S&P 500—the Dispersion Index measures broad expectations for fluctuations in stocks over and above their participation in market volatility over a short-term horizon.

4. What causes DSPX to rise or decline?  The index level rises when single-stock option prices increase relative to index option prices. The index level declines when single-stock and index option prices move closer in price.

The relative cost of stock and index options is driven, theoretically, by the magnitude of expected additional movement in single stocks compared to their index. Accordingly, the level of DSPX is expected to rise and fall together with market expectations for the magnitude of “opportunity” for outperformance via active stock selection among the S&P 500’s constituents.

5. Why was DSPX created?  The index was developed in collaboration between Cboe and S&P Dow Jones Indices (S&P DJI), applying the VIX methodology to both single-security and index options in order to create a high frequency indicator. The index may offer:

  • A measure of short-term S&P 500 dispersion expectations;
  • A benchmark for the evaluation of contracts linked to large-cap U.S. equity dispersion; or
  • An indicator of the short-term tracking error that active portfolio managers benchmarked to the S&P 500 may generate through stock selection.

6. What are the inputs to DSPX?  The level of the index is determined by the differences in prices of options on selected S&P 500 constituents and the prices of S&P 500 index options, as well as the weights of each constituent in the S&P 500 and representative interest rates for the period to maturity of all options included in the calculation.

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    An Overview of Return Types for Insurance Indices

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    Kevin Patalano

    Senior Analyst, Multi-Asset Indices

    S&P Dow Jones Indices

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    Maxime Fouilleron

    Analyst, Multi-Asset Indices

    S&P Dow Jones Indices

    Introduction

    Indices, including those used in insurance products, such as fixed index annuities (FIAs), registered index-linked annuities (RILAs) and index universal life (IUL), use one of these three return types: price return (PR), total return (TR) or excess return (ER).  These return types serve different purposes and are ultimately an element to consider as part of the overall construction of an index.

    Price return measures the capital appreciation (or depreciation) of an asset.  For an index, the price return measures the price fluctuations in the underlying constituents within the index.

    Total return measures the price return of an asset with dividends added.  As dividends are issued by underlying index constituents, the dividend amounts are theoretically reinvested in the underlying asset, which incrementally increases exposure to the underlying asset.  As more dividends are issued, more shares of the underlying asset are added to the index (or theoretically “purchased”), which in turn generates dividends paid on the original investment as well as these new shares, which are then again used to “buy” even more shares.

    Indices used in insurance products often contain exposure to an underlying equity index as well as a cash allocation.  A total return index used with insurance products would also typically include the theoretical return on the cash component if the index has a cash allocation invested at a certain rate, such as the Secured Overnight Financing Rate (SOFR), the federal funds rate or the yield on a 3-month U.S. Treasury bill.

    Excess return is often surrounded by confusion, since it can have different meanings depending on the context.  To simplify the term, we are going to break “excess return” down into two definitions.  

    In its simplest form, excess return measures a return above some sort of baseline.  The math is the same in both definitions, but the reason for using excess return can differ based on the industry.  

    • In the world of active management, excess return can be defined as the return above a benchmark, or “alpha”. Active managers of ETFs, mutual funds and hedge funds often measure the performance of their fund against a benchmark, like the S&P 500®.  Their goal is often to create as much alpha as possible.  In other words, they are looking to “beat the market.”
    • In the world of indices used with insurance products (e.g., FIAs, RILAs and IUL), excess return measures the return of one or more underlying assets minus an interest rate. This interest rate is subtracted to help improve hedge efficiencies, often leading to cost savings for the insurance carrier, which may ultimately benefit the end policyholder.

    It is worth noting that the term “excess return” is sometimes used as shorthand for “excess total return” or “excess price return” in the insurance space.  Most indices underlying insurance products are excess total return indices, meaning the theoretical interest rate is subtracted from the total return of the underlying assets in the index.  However, excess price return indices also exist in the insurance marketplace.  For the purposes of this piece and in order to align with the S&P Dow Jones Indices naming conventions, “excess return” will be used to refer to “excess total return.”

    It is not possible to invest directly in an index.  Exposure to an asset class represented by an index may be available through investable instruments based on that index.

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    A Closer Look at the SAR Government Sukuk Market

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    Jessica Tan

    Principal, Fixed Income Indices

    S&P Dow Jones Indices

    Introduction

    The iBoxx Tadawul SAR Government Sukuk & Bond Index was launched in 2020 in collaboration with the Saudi Stock Exchange (Tadawul) to track the performance of Saudi Arabian riyal (SAR) denominated domestic government bonds, including sukuk issued by Saudi Arabia.  The index seeks to track SAR-denominated fixed coupon bonds that have an amount outstanding of at least SAR 100 million.  As the Saudi government continues to enhance the accessibility and infrastructure of its domestic debt market through various initiatives such as the Primary Dealers Program, the index, which combines Tadawul’s market data with iBoxx indexing capabilities, provides transparency for the market and could serve as a market benchmark for domestic and international investors.

    Evolution of the Market

    At launch, the index had a significant portion of conventional debt in addition to sukuk.  It started out with 22 bonds (SAR 79.50 billion in amount outstanding, or 35% of the total) and gradually reduced to 7 bonds as of August 2023 (SAR 13.96 billion, or 3% of the total outstanding).  The portion of bonds within the iBoxx Tadawul SAR Government Sukuk & Bond Index has shrunk as the demand for Shariah-compliant instruments for domestic Islamic banks’ liquidity management purposes has favored sukuk over conventional bond issuances. 

    The Saudi Arabia domestic government sukuk market, as represented by the iBoxx Tadawul SAR Government Sukuk Index in Exhibit 1, has been growing steadily over the past few years, with most of the expansion occurring between 2019 and 2022, cementing the Saudi government’s position as the largest sovereign sukuk issuer globally.  Due to market volatility, interest rate changes and a surge in crude oil prices in 2022, Saudi Arabia, the largest oil exporting country in the world, has reduced its domestic debt issuances since 2022.  Since the index's inception (June 30, 2019), the number of sukuk has increased from 29 to 50 and the total notional outstanding has increased from SAR 146.95 billion to SAR 433.18 billion.

    Exhibit 1: Growth of the SAR Government Sukuk and Bond Market

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    Reflecting on 25 Years of the S&P/TSX Index Series and Its Impact on the Canadian Investment Industry

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    Michael Orzano

    Head of Global Exchanges Product Management

    S&P Dow Jones Indices

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    Sean Freer

    Director, Global Equity Indices

    S&P Dow Jones Indices

    Executive Summary

    2023 marks a quarter century since S&P Dow Jones Indices (S&P DJI) and the TMX Group partnered to bring investors what is today an innovative and comprehensive suite of Canadian stock market indices.  As Canada’s most widely followed stock market indicators, the S&P/TSX Index Series serves as the de facto measure of value and performance for multiple segments of the nation’s stock market.

    The past 25 years have seen significant market growth of the flagship S&P/TSX Indices, the S&P/TSX Composite Index and the S&P/TSX 60, and a transformation of how they are used.  Today, the indices serve an integral role in Canada’s investment infrastructure.  The asset management industry utilizes the S&P/TSX Composite Index and other related indices as the investable universe for active investment strategies and to benchmark fund performance.  Likewise, pension funds and other asset owners use the S&P/TSX Indices to benchmark their domestic portfolios.  With an estimated CAD 814 billion of Canadian equity funds benchmarked to S&P/TSX Indices, the series represents the most widely used benchmarks for Canadian equity funds by far.

    Perhaps most importantly, the S&P/TSX Index Series served as the foundation for the growth of index-based investing in Canada.  The deep ecosystem of liquid financial products tracking key S&P/TSX Indices allows active and passive investors to express investment views in an efficient manner.  S&P DJI’s SPIVA® research has also shined a light on the inability of most Canadian fund managers to beat their benchmarks, further highlighting the benefits of passive investing.  As has occurred in other parts of the world, the growth of index investing has democratized investment solutions that were previously only available to large institutions and lowered the cost of investing for millions of Canadians.

    The Evolution of the S&P/TSX Index Series

    Beginning with the introduction of the S&P/TSX 60 on Dec. 31, 1998, the partnership between S&P DJI and TMX Group has resulted in the development of a broad suite of investable indices measuring Canadian equities, covering a range of market segments and themes.  Less than a year after the launch of the S&P/TSX 60, Barclays Global Investors listed what is today known as the iShares S&P/TSX 60 Index ETF, which is now the largest ETF in Canada in terms of assets invested.

    The S&P/TSX Index Series subsequently evolved with the S&P/TSX SmallCap Index and the S&P/TSX Completion Index offering small- and mid-cap market benchmarks starting in 1999.  The years 2000 to 2002 saw the introduction of a suite of sector-focused indices, alongside S&P DJI introducing the Global Industry Classification Standard® (GICS®).  This development allowed investors to dissect market performance along sector lines and led to the creation of products linked to several Canadian sector indices beginning with the S&P/TSX Capped Energy and S&P/TSX Capped Financials.

    To complement the traditional market-capitalization-weighted indices, the noughties also saw the development of equal-weighted indices and dividend-oriented indices.  The S&P/TSX Canadian Dividend Aristocrats® Index was the first to offer exposure to high-yielding Canadian companies, followed by the S&P/TSX Composite High Dividend Index.

    The first Shariah-compliant index in Canada was established in 2008 with the launch of the S&P/TSX 60 Shariah.  The S&P/TSX 60 VIX® Index—known as the “fear barometer” of the Canadian market—launched in 2010 and measures implied equity market volatility.

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    TalkingPoints: The S&P 500® Sector-Neutral FCF Index — Why Free Cash Flow is King

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    Rupert Watts

    Head of Factors and Dividends, Product Management

    S&P Dow Jones Indices

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    George Valantasis

    Associate Director, Factors and Dividends

    S&P Dow Jones Indices

    While there are many metrics that can be used to evaluate the value of a company, free cash flow (FCF) is particularly useful when it comes to assessing financial health. FCF is the excess cash generated by a company after accounting for the cost of operations and capital expenditures. FCF may offer a clearer picture of a company’s profitability, since it is more difficult to manipulate than other measures such as net income.

    Importantly, companies with plenty of FCF have the flexibility to pay cash dividends, buy back stock, pay down debt and pursue growth opportunities—all important undertakings from an investor's perspective.

    The S&P 500 Sector-Neutral FCF Index is designed to track companies within the S&P 500 that exhibit high FCF yield relative to other companies within the same GICS® sector. By focusing on FCF yield, the index measures companies’ FCF generation relative to their value. Hence, it provides a means to track companies generating attractive levels of FCF that may be undervalued.

    1. What is FCF?

    Free Cash Flow = Net Cash from Operating Activities minus Capital Expenditures

    FCF represents the amount of cash generated by a business (i.e., operating cash flow) over a given period after accounting for cash outflows to support operations and to maintain capital assets. Simply put, it is the excess cash that a company generates after accounting for the expenses to run the business.

    2. Why is FCF an important metric for assessing a company?

    FCF offers a deeper understanding into the financial health of a company, since it shows the amount of cash that a company receives after meeting its obligations. A company with ample FCF has the flexibility to increase shareholder value through strategic investments and acquisitions. Furthermore, FCF can be used to increase shareholder yield via cash dividends, buybacks and paying down of debt.

    Companies producing plenty of FCF tend to be higher quality and may be better positioned to weather periods of market stress, as shown historically. Furthermore, in today’s environment of high interest rates, having a healthy cash flow has become particularly important since it reduces a company’s reliance on debt markets to finance business operations.

    3. What potential improvements does FCF offer over other measures of profitability such as net income?

    FCF differs from net income, which is used to calculate other popular valuation metrics such as the price-to-earnings ratio, since it focuses solely on cash transactions and is thus harder to manipulate. Under generally accepted accounting principles (GAAP) and accrual accounting, management is afforded more flexibility when recording sales and expenses. While FCF can still be manipulated (albeit to a lesser degree), it measures the exact amount of excess cash that was generated by the company in a given period. This is important because the capital returned via dividends or buybacks can only be funded with cash and not an accounting term such as “net income.”

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