Buckle Up, S&P 500 and Nasdaq Index Fund Investors. SpaceX Could Soon Become 1 of Your Largest Positions.

With an expected valuation of around $1.75 trillion, SpaceX will be the largest initial public offering (IPO) in history.

Here's why SpaceX going public on June 12 is a market-disrupting event unlike any other, and why index fund investors need to pay attention.

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SpaceX's path to becoming a foundational index fund holding

SpaceX plans to raise $75 billion, which would be just 4.3% of what is estimated to be a $1.75 trillion valuation. So despite being an incredibly valuable company, the percentage of shares outstanding available for trading by the public -- known as the float -- is incredibly small. The small float could create significant buying pressure on SpaceX from retail investors, as well as rules-based indexes and exchange-traded funds that will buy shares regardless of volatility.

In preparation for the SpaceX IPO, as well as OpenAI and Anthropic likely going public later this year, the major indexes have updated their rules. In the past, a company would have to prove itself to some extent on the public markets before being added. But this "seasoning period" meant that index investors missed out on some massive gains from stocks like Tesla, which wasn't added to the S&P 500 until December 2020, even though its market cap was over $300 billion at the time.

The Nasdaq's new Fast Entry pathway allows newly public companies whose market cap is in the top 40 of the current Nasdaq-100 constituents to be eligible for inclusion on their seventh trading day and then added to the index shortly after. The Nasdaq-100 represents the 100 largest non-financial companies by market cap.

To prevent tilting the balance of the index too much at once, a company may be added based on three or five times float-based market cap rather than total market cap -- which for SpaceX would be $225 billion to $375 billion if it does raise $75 billion at a $1.75 trillion valuation. That would put SpaceX at less than 1% of the Nasdaq-100 -- roughly around the market cap of a stock like Netflix on the high end and Qualcomm on the low end. So it's significant -- but not index-altering.

SpaceX's float should increase rapidly, as insiders can sell shares well before the typical 180-day lockup period. As insiders sell shares, the float will increase, allowing SpaceX to gradually gain a larger share of the major indexes.

S&P Dow Jones indexes proposed a similar plan to fast-track the inclusion of megacap companies in the S&P 500. S&P Dow Jones indexes defines megacap as a market cap in the top 100 of the S&P 500 Total Market Index -- which would be companies with a market cap of Altria ($154 billion) or bigger.

SpaceX's index-level impact is a multi-month event

At a $1.75 trillion valuation, if SpaceX were weighted based on its market cap rather than float, it would make up over 4% of the Nasdaq-100 and 2.4% of the S&P 500 -- putting SpaceX just ahead of Tesla as the seventh-largest holding in both indexes. Adding Anthropic and OpenAI to the major indexes will further concentrate the indexes in a handful of stocks, posing a risk to long-term investors.

The good news for index fund investors is that SpaceX won't become one of the largest holdings overnight due to updated index rules, but an accelerated lockup period could rapidly increase its float and pressure buying in the coming months. Investors who want to avoid this buying pressure may consider exchange-traded funds with rules that offer greater flexibility rather than forced buying.

Daniel Foelber has positions in Netflix. The Motley Fool has positions in and recommends Netflix, Qualcomm, S&P Global, and Tesla. The Motley Fool recommends Nasdaq. The Motley Fool has a disclosure policy.