Whilst many traders and investors are aware that the companies listed on the ftse 100 index change on a regular basis, few have any idea how these changes are managed or indeed why! To be successful spread betting ftse 100, you will need to understand how these changes are made, when they happen and why, so let me explain the structure of the index and how it is managed by its parent company. As outlined above, the ftse index is a constantly changing indicator, and every quarter a review takes place of the constituent companies with some leaving the index, and others joining to replace those that have left. This process takes place during March, June, September and December, every year. As we have already seen the index is based on the market capitalisation of the companies themselves, and this is the principle governing factor which dictates whether a company shall be included or excluded from the index, all of which is calculated using something called the ‘free float’ method.
Free float methodology is now the most widely accepted form of best practice for index construction, and is used throughout the world on all the major indices such as the FTSE, STOXX, Standard & Poor’s, and Dow Jones. In simple terms free float is defined as that proportion of the total number of shares issued by a company which are freely available for buying and selling in the market. In other words it excludes all those government holdings, strategic holdings and other shares which are locked in and not available to the market. In the UK for the FTSE 100, the factor used is often called the free float adjustment factor, which represents the number of shares floated or freely available, as a percentage of the number of shares issued. This is then rounded up to the nearest 5% for calculation purposes. To calculate the index level for the FTSE 100 a simple formulae is applied which is as follows: FTSE 100 Index Value = Total sum of (share prices x shares issued x free float factor)/index divisor. The formula uses a divisor called an index divisor which simply links the index back to its original base year for comparison purposes over time, and in the case of the FTSE 100 the base value is 1000 which is where the index started when it was first created in 1984. This is calculated every 15 seconds during the ftse trading session.
The next element you need to understand as a ftse trader, is that of market capitalisation. As explained previously, all the constituent shares are weighted to form was is called a capitalisation weighted index. In simple terms what this means is that each share contributes its market value to the index so that the larger the company then the greater the weight they carry as a result, and as we have already seen earlier, BP which is currently at number one in the index, carries a weight of 8.05% in determining the overall index value on a daily basis. In order to outline how all the above works let’s take a simple example and suppose we are developing a new index with two shares, Great Mining plc (GM) and Profitable Oil (PO) plc. Suppose that Great Mining plc has 1000 shares, but 200 of these are not freely available to the market, and similarly Profitable Oil plc has 2000 shares, with only 1000 shares freely available. Then the free float value number of shares for GM plc is 800, whilst for PO this is 1000. Next let’s assume the share price for GM is 120p and for PO is 200p, then the free float market capitalisation of GM plc is ( (1000 – 200) x 120) = 96,000 , and for PO plc it is ((2000 – 1000) x 200) = 200,000. If we then add these two figures together we arrive at our free float market capitalisation for our new index at 200,000 + 96,000 = 296,000, and as this is a new index we can now decide on our index divisor in order to reduce the index to a more manageable number, so in this case we could assume 1000 to start, as for the FTSE 100 and arrive at our index value for today of 296,000/1000 = 296. This in very basic terms is how the index is calculated using the free float method with weighted market capitalisation of the constituent shares, and in our simple example Great Mining plc would represent 32.5% of the index whilst Profitable Oil plc would represent 67.5%. On a simple share price comparison basis then the ratio would be 40%/60%, but using the above comparison provides a more balanced and weighted view of the index, which is why it is widely used throughout the industry. Finally let’s look at how the constituent shares are rotated on a regular basis following each quarterly review.
Each quarter in March, June, September and December, the constituent shares are reviewed on the Tuesday evening at the close of business and are then ranked by full market capitalisation for all the main indices from the FTSE 100, to FTSE 250, FTSE SmallCap and finally the FTSE Fledgling. Any company falling to 111th position or below is automatically removed from the FTSE 100 and demoted to the FTSE 250, and similarly any company which rises above the 90th position or above is automatically added to the index. As the number of constituents for the index remains at 100 there is then a re balancing during the review process with the highest ranking ftse 250 companies entering the index as a result. This process also occurs throughout the other indices with different band levels for automatic entry and exit, with these set at 325 for automatic entry and 376 for automatic exit in the FSTE 250.
As I hope you are beginning to see, there is a great deal of complexity to what superficially appears to be a very simple index, and to be successful in ftse betting, you need to understand how the index works, what are the constituents and how they are managed, and finally when the constituents change, as this will have an impact on the price quoted both immediately before and after these important quarterly changes. Finally, I hope that I have made the case that this key index is far from being an indicator of UK plc – it is not, and in order to trade this financial instrument successfully you will have to follow world markets in a great deal more detail, and in particular the commodities sector which dominate the index to such a large degree.
Latest UK equity news for FTSE 100 constituents
Small-caps: French Connection out of fashion
6 Feb 2012 at 10:42pm
Troubled retailer falls after revealing disappointing Christmas results late on Friday which it said negated its positive first-half growth
FTSE lower as investors remain cautious
6 Feb 2012 at 8:07pm
Shares edge lower with Barclays out of favour on concerns that it might kick off the bank earnings season on a downbeat note
Investors seek Bumi talks with Bakries
6 Feb 2012 at 10:49pm
Shareholders want the Bakrie family and their partner Samin Tan to withdraw a motion calling for Nat Rothschild to be ousted from the company’s board
Randgold to spend $1bn developing mines
6 Feb 2012 at 4:27pm
Gold miner seeks to double dividend as increased production of the precious metal combined with high prices more than trebled annual profits
Small-cap week: Coms surges on Smith share deal
3 Feb 2012 at 10:48pm
Internet telephone service provider gains 168% after chief executive of MXC Capital increases stake
Unilever agrees to return to negotiations
3 Feb 2012 at 10:34pm
Unilever feels the ‘time is right’ to see if Acas can help resolve the dispute after it closed its final salary scheme
Small-caps: Game bounces back
3 Feb 2012 at 9:42pm
Agreement with lenders lifts troubled retailer while brewer Fuller’s rises after announcing the purchase of 15 pubs from Enterprise Inns for £22.9m
Bakrie vehicle moves to oust Rothschild from Bumi
3 Feb 2012 at 8:50pm
Dramatic move is a setback for the UK financier, who had pledged to clean up corporate governance at the coal miner
Chartists have a cross to bear
3 Feb 2012 at 6:21pm
Analysts’ favourite is little help in spotting trends, says David Schwartz
Broadband take-up boosts BT earnings
3 Feb 2012 at 6:10pm
Pension deficit widens £1.6bn, but pre-tax profit for third quarter is up 48% at the UK telecoms group
