Don, My point is that the arbitrageurs will keep the relationship between the two so tight that there won't be any discrepancies that could provide any clues as to market direction. Also, when the arbitrageurs trade, they wouldn't normally trade all 500 stocks. They would trade what's called a 'basket' of stocks which would represent most but not all of the index. What you risk on not having a completely perfect hedge is overshadowed by lowered transaction costs. For example: When I 1st started the dollar index arbitrage there were 20 currencies involved. I didn't trade any of the minor currencies unless I absolutely had to to balance out the hedge. Normally I'd trade d-marks, swiss, yen and the occasional british pound. Trading those four gave me a good approximation of the index movement, and I didn't have to bother trying to find markets on drachmas or punts.