Standard & Poor's depositary receipt exchange traded funds, or SPDR ETFs, began trading on the American Stock Exchange (AMEX) in 1993, when they were first issued by State Street Global Advisors' investment management group. SPDRs - also sometimes referred to colloquially as "spiders" - are index funds that initially were based on the S&P 500 Index. Each share of the traditional SPDR ETFs holds a stake in the 500 stocks represented by the S&P 500.

Shares of a spider ETF differ from mutual fund shares in that, unlike mutual funds, spider ETF trust shares are not created for investors at the time of their investment. SPDRs have a fixed number of shares that are bought and sold on the open market. This is because SPDR ETF shares represent proportional interest in the unit investment trusts that hold the stocks of each of the underlying indexes that they represent.

Because these shares represent interest in the underlying unit investment trusts, holders of SPDR shares have some voting privileges. Rather than voting on proxies that pertain to all of the underlying stocks of an index, however, spider owners vote on special proxies that represent the unit investment trust. (The unique structure of these vehicles opens multiple opportunities for investors. Find out what they are in Advantages Of Exchange-Traded Funds.)

Spider Expansion Into S&P Sectors and Capitalization
As the success of spiders grew, new SPDR ETFs were launched that branched out to include other investment options. These varied SPDRs include specializations based on capitalization and industry sectors within the S&P 500. These sub-groups of SPDR investment vehicles started slowly. They first began including SPDRs based on different sectors of the S&P 500, such as the Consumer Discretionary Select Sector S&P Index, The Financial Select Sector S&P Index and the Healthcare Select Sector S&P Index.

In addition to specializing in sectors, SPDRs began to be developed that were based on varying capitalization sizes of companies, such as mid cap SPDRs, which track the performance of middle-sized companies that are part of the S&P 500. (ETFs are a viable alternative to mutual funds, but before you invest, there are a few things you should know; read Using ETFs To Build A Cost-Effective Portfolio.)

SPDRs became so successful that they were created for the Dow Jones Industrial Average (DJIA). The SPDR Dow Jones Large Cap ETF kept the term SPDR even though it was no longer related to the S&P 500 Index. In fact, as a result of their success, there are now hundreds of versions of SPDR funds that track various indexes around the globe. And while there are other index funds that compete with them, SPDRs are often regarded as the thoroughbreds of their investment strategy.

How to Buy and Redeem Spiders
SPDR ETFs trade on this secondary market much like stocks and even have trading symbols. The purchase or redemption price is determined by the net asset value (NAV) at the time of the transaction.

The value of each unit in any SPDR ETF trust at any given time reflects the movement of the underlying index. Traditional SPDRs, for example, trade at approximately one-tenth of the level of the S&P 500. If the S&P 500 is at 1,800, for example, the SPDR ETF shares will trade at $180 per unit. Mid cap SPDRs, however, trade at one-fifth of the level of the MidCap 400 Index. If that index is at 300, for example, the SPDR will trade at $60 per unit. (Learn more in our Exchange Traded Fund Tutorial.)

SPDR Options, Futures and Hedging
Since SPDR ETFs function as stocks when it comes to how they are traded, they also can be sold short, optioned, bought or sold on the futures market. These features allow investors to make smaller bets on where the market's headed, since the SPDRs trade at a fractional level of the overall index. And while these trading strategies can be risky, they can also be used in measured ways to mitigate the risk of a portfolio.

When an investor enters a long position by investing in the S&P 500 SPDR ETF, for example, that investor will make money as long as the S&P 500 Index goes up. If the index goes down, however, the investor will begin to lose money on the investment. If that same investor, however, hedges his or her bets by also shorting the SPDR or selling S&P 500 futures contracts, that loss can be mitigated. These are just some of the ways SPDRs can be used to hedge the market. (For a better understanding, check out A Beginner’s Guide To Hedging.)

SPDRs: Potential Advantages and Disadvantages
The potential advantages of SPDR ETFs are numerous. They have the ability match the performance of an index. And while active managers rarely outperform an index, investing directly in a vehicle that tracks the performance of the index is an attractive option. (These ETFs take the sector rotation strategy from institutional investors and puts it in your hands Sector-Based ETFs Spread Out Risk.)

SPDRs also have the flexibility to give a depth of market exposure through one of the ETFs that tracks a broader index, or diversify a portfolio by investing in one of the SPDRs that specializes in a sector or specific market capitalization of companies. SPDRs also have the flexibility to be used as hedging instruments.

One of the potential risks of investing in long positions of SPDR ETFs, however, is that the general level of the index may precipitously decline. If hedging precautions aren't taken, the SPDR ETF is vulnerable because it will fall as well as rise with the index it tracks. Also, some active managers have outstanding records of outperforming an index. By investing in a vehicle that closely tracks an index's performance, the investor misses out on that potential upside.

The Bottom Line
All in all, SPDR ETFs offer an investment option well worth considering. Investors should weigh the pros and cons and discuss the possibility of such a position with their financial advisors. These ETFs may indeed represent a unique spider that even those with arachnophobia will be attracted to. 

by Christina Granville, (Contact Author | Biography)

Christina Granville is a graduate of Yale University and the London School of Economics. She has held officer-level positions at Morgan Stanley and Alliance Capital. She has also worked as a consultant for financial service firms and investment banks, including Goldman Sachs, and as a writer for financial and executive publications such as the Financial Times Executive Briefing Series.