There's no dispute that International Securities Exchange (ISE: sentiment, chart, options) is one of the hottest stocks in one of the hottest sectors. I touched briefly on this stock in last week's observation titled Sector Update: A Look at the Exchange Sector.

The International Securities Exchange was founded in 2000 by former E*Trade Financial (ET: sentiment, chart, options) executives William Porter and Martin Averbuch, with help from former New York Stock Exchange (NYX: sentiment, chart, options) executives David Krell and Gary Katz.

The ISE, which was launched May 26, 2000, became the first registered exchange approved by the Securities and Exchange Commission since 1973, and a member-owner of the Options Clearing Corporation. It was funded by a consortium of broker-dealers whose purchase of exchange memberships provided initial development capital.

ISE has since become the world's largest equity options exchange, based on volume. In addition to proprietary trading software and tools, the ISE offers educational programs and training for investors and ISE member firms. On March 9, 2005, ISE became the first securities exchange to sell its shares in an initial public offering.

For those who invested in ISE stock in March 2005, the ride has been a profitable one. From its first day close of $30.40, the stock is up more than 64 percent. That's almost a 36-percent annualized return.

One of ISE innovations has been their introduction of various sector and market segment indices. They range from broad-market indices such as the ISE 250, ISE 100, and ISE 50 to more sector-specific indices. A list of those indices and descriptions can be found below.

ISE INDICES

ISE 100 (IXX) – The ISE 100 Index is a higher-volatility indicator that tracks the performance of the top 100 most actively traded equity option classes listed on ISE. Similar to the ISE 50 and ISE 250, the ISE 100 is a capitalization-weighted index. However it does not include stocks on the basis of market capitalization.

ISE 250 (IXZ) – The ISE 250 Index tracks the top 250 U.S. stocks trading on the NYSE, AMEX, and NASDAQ. The companies represented have an adjusted market capitalization of approximately $9 trillion.

ISE 50 (IXK) – The ISE 50 Index tracks the performance of the "Mega Cap" stocks listed in the United States. The Index is a subset of the ISE 250, generally including the top 50 stocks.

ISE Bio-Pharmaceuticals (RND) – The ISE Bio-Pharmaceuticals Index includes companies primarily engaged in researching, developing, manufacturing, producing, or marketing pharmaceuticals or other products based on biotechnology research.

ISE Gold (HVY) – The ISE Gold Index includes companies that own or operate gold mines, or are involved in the production of gold and related products.

ISE Homebuilders Index (RUF) – The ISE Homebuilders Index includes residential construction companies and prefabricated house manufacturers.

ISE Integrated Oil and Gas (PMP) – The ISE Integrated Oil & Gas Index includes companies engaged in the exploration, production, refining, marketing and transportation of oil and gas.

ISE Oil and Gas Services (OOG) – The ISE Oil & Gas Services Index includes oil and gas drilling contractors, equipment manufacturers and suppliers, and service providers involved in drilling, evaluation and completion of oil and gas wells.

ISE Semiconductors (BYT) – The ISE Semiconductors Index includes manufacturers of semiconductors and related equipment.

ISE SINdex (SIN) – The ISE SINdex includes owners and operators of casinos and gaming facilities, producers of beer and malt liquors, distillers, vintners and producers of other alcoholic beverages, and manufacturers of cigarettes and other tobacco products.

ISE U.S. Regional Banks (JLO) – The ISE U.S. Regional Banks Index includes companies active in small and medium corporate lending and retail banking. Regional banks operate in limited regions within the U.S. Companies are primarily engaged in investment banking, brokerage, and asset management are not included in the index. Thrifts and mortgage banks are also not included.

ISE Water (HHO) – The ISE Water Index includes companies engaged in water distribution, water filtration, flow technology, and other water solutions.

ISE-CCM Alternative Energy (POW) - The ISE Alternative Energy Index includes companies engaged in the development of technology relating to alternative energy sources such as: geothermal heat, hydrogen/fuel cell, hydropower, nuclear fusion, solar energy, and wind energy.

ISE-CCM Homeland Security (HSX) – The ISE-CCM Homeland Security Index includes companies engaged in contractual work with the Department of Homeland Security, law enforcement agencies, or providing products or services for the following efforts: intelligence and warning; border and transportation security; domestic counterterrorism; protection of critical infrastructure; defense against catastrophic threats; and, emergency preparedness and response.

The ISE-CCM Homeland Security Index was jointly developed by ISE and Cronus Capital Markets, Inc. (CCM). CCM, an independent and privately owned capital market research and consulting firm, provides specific research and support for the Index.

ISE-CCM Nanotechnology (TNY) – The ISE-CCM Nanotechnology Index includes companies involved in the science and technology of building electronic circuits and devices from single atoms and molecules. Applications involve the intended ability to manipulate materials to fundamentally improve processes, materials, and devices on an 'atomic' scale.

ISE-Revere Natural Gas (FUM) – The ISE-REVERE Natural Gas Index has been created to allow investors to quickly take advantage of both event-driven news and long term trends in the natural gas industry. The securities selected for the index derive a substantial portion of their revenues from the exploration and production of natural gas.

Not only do these indices have interesting ticker symbols, but more importantly, they also have characteristics that make them valuable proxies for certain market sectors. Those include the broad coverage of the sectors, the focus on equal weighting and the number of stocks in each index.

Each industry index attempts to capture at least two-thirds of the entire industry's market capitalization. Due to the non-uniform weight distribution across entire industries, an equal-weighted methodology or a "modified" market capitalization-weighted methodology is used to adjust the weighting of component stocks. Individual component weightings are limited to 25 percent at semi-annual reviews for modified capitalization-weighted indices. This modification prevents a few large component stocks from dominating the index and distorting an index return that is representative of an industry sector. The modified approach promotes portfolio diversification by retaining the economic attributes of capitalization ranking.

The equal-weighted methodology ensures each component stock is equally represented in the index. This methodology is used when there is an especially wide divergence in the market values of those components. Quarterly rebalancing events are used to "re-set" the weighting of each component such that each component has an equal influence on the index performance.

The ISE Industry Indices contain a maximum of 20 different component stocks. New companies are added to the indices when an existing component is removed. Companies may not apply, and may not be nominated, for inclusion in the indices. Whenever possible, ISE will publicly announce changes to the index on its website at least five trading days in advance of the actual change.

All in all, these indices offer a unique opportunity to gain exposure in certain untapped market segments. I've written about some of these here before. During the coming weeks, I'll take a closer look at more of these specific indexes and their uses.