Tesla Joins the S&P 500: Five Things to Watch

Tesla Inc.

TSLA 5.32%.

will be officially added to the S&P 500 on Monday, which should cause some commotion in the markets on Friday afternoon.

The manufacturer of electric cars will be by far the largest company by market value ever included in the S&P, the most widely followed stock market index. The addition of Tesla will encourage dozens of index funds that follow the S&P to try to buy tens of billions of dollars in shares at Friday’s closing price in order to follow the index as closely as possible. Due to the size of the company and the volatility of the shares, the addition of Tesla can influence the market in an additional and unpredictable way, according to the traders.

A spokesman for S&P Dow Jones Indices, which oversees the S&P 500, said the company has consulted with market participants and communicated the addition to the market well in advance of typical index changes.

Here are five points to watch out for:

1. Quadruple production

The inclusion of Tesla in the S&P 500 coincides with a fourfold multiplication, which takes place four times a year and relates to the day on which option and forward contracts on indices and shares expire simultaneously. These larger volumes will increase liquidity and probably help facilitate Tesla’s inclusion in the S&P, the traders said.

Tesla would then be the sixth largest company in the index, valued at $622 billion, after an increase of almost 700% this year. RBC Capital Markets estimates that about 3 percent of the assets that passively follow the S&P are about $4.7 trillion traded on Friday. This is more than the triple of what S&P achieved at the last rebalancing in September.

Traders say that the strong activity can cause major shifts in the market, because the shares of the companies in the index must buy and sell to adapt to the Tesla, which weighs about 1%. Real estate investment fund

Apartment Investment and Management Ltd.

is removed from the index, for example. RBC values the shares of companies as follows

Xerox Holdings Corp.

Berkshire Hathaway Inc.

Intel Corporation.

may be subject to sales pressure, partly due to the weighting of the index.

Tesla’s increase will also impact the S&P Completion Index, which tracks all U.S. shares except the S&P 500. Other indices, such as the S&P 400 and S&P 600, which track mid-cap and small-cap companies, and the Nasdaq-100, will also adjust their positions.

2. Troubleshooting

Index funds that follow the S&P 500 have a small window on Friday to buy lots of Tesla shares. If they receive too much, too little or not the closing price, the difference is recorded as a tracking error, reflecting the price difference between the fund’s purchases and the index it follows. Fund managers do not like it because they make it difficult for them to meet the standards.

The index funds plan to complete most, if not all, of their Tesla purchases on Friday close to the S&P price, several traders and investors said. But the expectation of strong demand could make this difficult, traders added. In recent weeks, some investors have wondered if there will be enough sellers at the table, given Tesla’s famous passionate fan club and the large number of passive investors that are expected to buy.

All this can cause major fluctuations in Tesla’s stock.

Nasdaq Inc,

where the Tesla share is listed, and regulators have considered raising the price caps to allow the share to rise above the current 10% cap before trading is discontinued, an expert said. The limit values have not been changed.

Elon Musk’s optimism and proximity to grand statements that would once have undermined his credibility may have made him the second greatest man in the world. The WSJ is investigating how a pandemic was dealt with. Photo: Britta Pedersen/Zuma Press

3. Last 30 minutes of trading

The addition of Tesla increases the value of the closing auction, which determines the final price of thousands of shares. The Nasdaq takes so-called ‘close market’ orders throughout the day. At 15:50 EST, the exchange operator starts spreading information about imbalances in the market or too much demand to buy or sell Tesla. At this point the traders will enter the game and probably reach new heights on a crazy day.

Minutes before closing the trade, when the imbalance signal arrives, many algorithms start paring imbalances or positioning their trade, said Shishir Gupta, Global Index Strategist at RBC Capital Markets.

4. Derivatives market

Traders are also keeping an eye on how the huge expansion will affect the derivatives market. The Tesla share has been almost three times as volatile as the S&P this year, with an average daily movement of 4.1% compared to 1.4% for the index. Volatility is an important factor in the pricing of options, which means that the addition of Tesla could influence the prices of S&P 500 option contracts and other derivatives, traders and analysts. The exact impact is unclear and will depend on the degree of volatility of Tesla and the correlation with the rest of the components of the index, said the traders.

You have a much more volatile participant – a participant who largely joins the index and without any real evidence or historical precedent, says Cem Karsan, senior partner at the volatility garage fund Aegea Capital Management LLC, which traded Tesla options. They have to influence each other.

5. Small reserves

According to the traders, the addition of Tesla could also stimulate the circulation of small-cap shares sold to make way for them. The sale could lead to a reduction in liquidity, which could result in a sharp drop in the price of some shares.

Tesla road to the S&P 500

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Email Gunjan Banerjee at [email protected] and Michael Wursthorn at [email protected].