Do you like the S&P 500 Index ($SPX)? Of course you do! I’m assuming that because you’ve seen it rise continuously for about a decade, with only a few sharp-but-brief pullbacks along the way.
I’ve been scouting, analyzing and investing in exchange-traded funds (ETFs) since there were ETFs. So, it takes a lot for me to get pumped up over one of them. And when I do, as with the iShares Top 20 U.S. Stocks ETF (TOPT), it’s a big deal.
The appeal of this ETF to me is less about immediate gratification, although it’s still hanging in nicely after a big runup since its debut 10 months ago. It is the utility of it, versus the broader, but not necessarily more effective, SPDR S&P 500 Trust ETF (SPY) and other ETFs that track the full S&P 500.
The simple point here is that while the S&P 500 sounds diversified, that benefit is not nearly as effective as traders might think. For years, the S&P 500 has been driven by a dominant factor: big stocks getting bigger, to the point where a small fraction of SPY’s 500 holdings actually influence its performance.
So, why not also devote some attention to those very drivers of the S&P 500. Specifically, the 20 largest stocks. They drive the returns.
There are ETFs that track the top 50, top 100 or top 200 S&P 500 stocks. So there are gradients here. But in this article, I’m cutting to the chase, to the core of the matter.
The top 20 have been the profit-makers, and if the market continues to be a case of the giants getting bigger, and the rest just tagging along, TOPT is a must-follow. It is now for me.
TOPT has no 12-month return yet, but there’s a lot to be learned from the fact that it has outperformed SPY over multiple time frames so far. Most significant to me is the year to date. That’s because we had such an awkward and historic drop and recovery.
In the environment we are in, and could be in for a while, the simplicity and edge in knowing exactly what you own with TOPT is a rare advantage for traders.
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Let’s compare the top 20 holdings of SPY and TOPT and see why.
Here’s SPY’s top 20. The allocations per stock quickly drop off in size.
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For TOPT, these top-20 holdings are, by definition the whole fund, but for some cash and one extra position which is likely still there due to TOPT’s rebalancing rules. It is still very top-heavy, but just knowing that these market leaders are what you own allows us to track why TOPT is moving as it is.
I think that information advantage is critical in ETF investing, and it is why I prefer more concentrated equity funds.
TOPT’s chart looks a lot like SPY, but those top holdings have taken it higher on a percentage basis.
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Surprisingly or unsurprisingly, TOPT has options trading. I say that because nearly every ETF has some type of options capability. However, as is the case with TOPT, there’s practically no volume.
That doesn’t mean we can’t find reasonable options to consider. Like the one I found below. It is not a collar, it’s a protective put purchase.
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While this could be used to try to profit from a market decline, I’m going to assume here that 100 shares of TOPT are owned, and that the put option purchase aims to take away the risk of major loss if this fall gets nasty.
Here’s the key to me: For just $1.40 a share, in this low volatility environment, TOPT can be hedged for nearly 3 months, at the current price ($29 per share). That’s 5% downside risk, and all the upside. There is no volume or open interest, so if you traded this particular contract, you’d be the first. But the underlying stocks in TOPT are so liquid, a market can be made, with reasonable spreads.
TOPT opens up a world of possibilities, from using it as a stock tracker, to adding emphasis to an S&P 500 portfolio, and even to hedge some of those top names. Ironically, this new ETF, which is a highly concentrated portfolio of top U.S. stocks, has a diverse set of applications for traders and investors.
On the date of publication, Rob Isbitts did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. This article was originally published on Barchart.com
