piders and diamonds have entered the investing world's lexicon, offering lower cost alternatives to index funds.

But are they really better investing vehicles than, say, mutual fund indexes? The answer hinges on your investment strategy and your own expectations.

Spiders and diamonds are unit investment trusts (UIT) that own stock positions to match a market index. They were designed by borrowing here and there - a little bit of mutual fund, a lot of unit investment trust - to make an entirely new instrument.

Mutual funds are open-ended, meaning that shares are created and redeemed every day by the fund company to meet investor demand. In contrast, a closed-end fund issues a fixed number of shares that trade like stocks on an exchange.

Historically, a unit investment trust has had both a fixed number of shares and a fixed portfolio. They were not very attractive investments. But that is changing. New forms of UITs are being offered to allow investors to target a specific group of securities and to buy them at a low cost, making them a better investment in many cases than a mutual fund. And that is where the spiders and diamonds come in.

Spiders, which is an acronym for Standard & Poor's Depositary Receipts (SPDRs) invests solely in the 500 stocks of the Standard & Poor's Index. It was the first open-ended UIT, says Dan Noonan, spokesman for the American Stock Exchange.

Conversely, diamonds invest in the Dow Jones Industrial Average. A diamond, which is now traded on the American Stock Exchange, represents roughly 1/100th of the value of the Dow. So with the Dow at around 8,000, one diamond would cost $80. A round lot of 100 would cost $8,000.

The American Stock Exchange expects diamonds to be popular with retail investors because of the Dow's name recognition. "The S&P 500 is the benchmark for institutions but the Dow has more name recognition with the everyday investor," Noonan says.

"Stockbrokers will be pushing these things like crazy," adds Ram Kolluri, an investment manager in Princeton, N.J. "They'll tell you you can't go wrong by investing in the Dow."

The ubiquity of the Dow is hardly a sound argument for buying a diamond. The Dow represents one share each of 30 large-company stocks. It is not an index. Unlike the S&P 500, which is weighted by market capitalization, the Dow 30 is a price-weighted average. "I can't imagine buying the Dow 30," says Harold Evensky, an investment manager in Coral Gables, Fla. "It's got a huge historical significance. But it's not diversified."

That leaves us with spiders, and fund managers looking to cash in are copying or adapting their own versions.

For example, discount broker Charles Schwab & Co. recently introduced a unit trust that invests in the "Dogs of the Dow," or the 10 highest dividend-yielding stocks in the Dow Jones Industrial Average. The portfolio is not static. It is rebalanced every year to take advantage of the dogs strategy - that the stocks with the highest dividends outperform the overall market.

The spider resembles an index fund, like the Vanguard 500 Trust. But the spider has some advantages.

Both are extremely low-cost: 18-1/2 basis points for the spider and 20 basis points for the Vanguard 500. That's much lower than the full 1-to-2-percentage points assessed as fees on many mutual funds.

The S&P 500 stocks are the only investments permitted for the spiders, which must stay fully invested. When a shareholder wants to sell, the shares go back into the open market and are purchased by another shareholder.

An index mutual fund aims to stay fully invested, too. But the manager must be ready to redeem shares if investors want to sell. So he typically keeps a small amount in cash. The Vanguard Index 500 also is permitted to buy futures, says John Woerth, a Vanguard spokesman.

A bigger argument for spiders, however, is their tax efficiency. Shares of the S&P 500 Index contain imbedded capital gains because the underlying stocks have been held for some time and have appreciated in value. When they are sold, the mutual fund must distribute those gains to all shareholders.

Should the market crash and lots of investors bail out, the index fund manager might be forced to sell appreciated stock to raise money to redeem the shares, generating capital gains. The shareholders would then have to pay tax on those capital gains.

"When a large institution sells mutual fund shares, it passes off the gain to everyone else in the fund," Noonan says.

In contrast, spiders do not redeem shares from investors, who buy and sell them on the Amex. Institutional investors are permitted to create and redeem shares. But they must do so "in kind," in lots of 200,000. In other words, if an institution wants to redeem spiders, it would redeem them into shares of the underlying stock. "They are simply converted by the issuer into stock," Noonan says. This prevents the capital gains from being distributed to all the other investors who continue to hold their shares. The result is spider investors save the capital gains tax, thus increasing their return when compared with the same investor of a mutual fund.

For this reason, investment manager Kolluri replaced the Vanguard 500 with spiders in his client portfolio. "My largest position is in spiders," he says. "I use the spiders as the portfolio anchor and then build value and growth and international positions from there."

Kolluri predicts there will be many more trusts like the spiders and diamonds to choose from by the end of 1998. "I wouldn't be surprised to see a Nasdaq 100 or a prepackaged commodity instrument," he says. "Wall Street is finding newer and better ways to package the same old wine."