Underlying Asset

Loading the player...

What is an 'Underlying Asset'

An underlying asset is a term used in derivatives trading, such as with options. A derivative is a financial instrument with a price that is based on (that is, derived from) a different asset. The underlying asset is the financial instrument (such as stock, futures, a commodity, a currency or an index) on which a derivative's price is based.

BREAKING DOWN 'Underlying Asset'

For example, an option on a stock gives the holder the right to buy or sell the stock for a specified amount (strike price) at a certain date in the future (expiration). The underlying asset for the stock option contract is the company's stock.

An underlying asset can be used to identify the item within the agreement that provides value to the contract. The investor has the option, or the right, to buy the aforementioned asset at an agreed upon price on a particular date, known as the expiration. The underlying asset supports the security involved in the agreement, which the parties involved agree to exchange as part of the derivative contract.

Example of an Underlying Asset

In cases involving stock options, the underlying asset is identified as the stock itself. For example, in a stock option to purchase 10 shares of Company X at a price of $100 on September 15, the underlying asset is the stock in Company X. The underlying asset is the asset used to determine the value of the option as the contract is created. The value of the underlying asset may change before the expiration of the contract, affecting the value of option and assists the buyer in determining if the option should be exercised.

The underlying asset can also be related to stock market indexes, such as the S&P 500. In the case of indexes, the underlying asset is comprised of the common stocks within the stock market index.

Understanding Derivative Contracts

A derivative contract is used in relation to options and futures. The price of the option or future is derived from the price of an underlying asset. In an option contract, a seller must either buy or sell the underlying asset to the buyer on the specified date at the agreed-upon price. The buyer is not obligated to purchase the underlying asset, but he can exercise his right if he chooses to do so. If the option expires, and changes in the market make the purchase unfavorable for the buyer, the buyer can then choose not to participate in the transaction.

RELATED TERMS
  1. Underlying Option Security

    An underlying option security is the financial instrument on ...
  2. Underlying Security

    The security on which a derivative derives its value. For example, ...
  3. Derivative

    A security with a price that is dependent upon or derived from ...
  4. Put

    An option contract giving the owner the right, but not the obligation, ...
  5. Call Option

    An agreement that gives an investor the right (but not the obligation) ...
  6. Underlying

    1. In derivatives, the security that must be delivered when a ...
Related Articles
  1. Managing Wealth

    Explaining Underlying Assets

    An underlying asset is the financial instrument from which a derivative's price is based.
  2. Trading

    Examples Of Exchange-Traded Derivatives

    We look at some of the most common exchange-traded derivatives.
  3. Trading

    Derivatives 101

    A derivative investment is one in which the investor does not own the underlying asset, but instead bets on the asset’s price movement with another party.
  4. Investing

    Derivatives 101

    Learn how to use this type of investment as an alternative way to participate in the market.
  5. Trading

    4 Equity Derivatives And How They Work

    Equity derivatives offer retail investors opportunities to benefit from an underlying security without owning the security itself.
  6. Investing

    Options on Futures

    Options on futures contracts offer another way for day traders to use options. These are traded on the same exchange as the underlying futures contract. Traders should take care to understand ...
  7. Trading

    Options Pricing: A Review Of Basic Terms

    The following is intended as a review of basic option terminology, which can be used as a reference as needed: American Options - An option that can be at any point during the life of the contract. ...
  8. Trading

    5 Equity Derivatives And How They Work

    These derivatives allow investors to transfer risk, but there are many choices and factors that investors must weigh before buying in.
  9. Trading

    A Guide Of Option Trading Strategies For Beginners

    Options offer alternative strategies for investors to profit from trading underlying securities, provided the beginner understands the pros and cons.
  10. Trading

    Introduction - Day Trading and Options

    Options have not been a tradition part of day-trading strategy, but this is quickly changing.
RELATED FAQS
  1. What does the underlying of a derivative refer to?

    Find out more about derivative securities, what an underlying asset is and what the underlying assets refer to in stock options ... Read Answer >>
  2. What is the difference between derivatives and options?

    Learn how options are one type of derivative and how equity options derive their value from a stock, and understand other ... Read Answer >>
  3. How can derivatives be used for speculation?

    Find out more about derivative securities, speculation and how derivatives could be used to speculate on the price of the ... Read Answer >>
  4. What expiry months are typically available for derivatives?

    Discover more about the derivatives market and learn about the varying expiration months for derivatives in different financial ... Read Answer >>
  5. What kinds of derivatives are traded on an exchange?

    Learn about the different types of derivatives traded on exchanges, including options and futures contracts, and discover ... Read Answer >>
  6. What does it mean to be long or short a derivative?

    Find out more about derivative securities and what it indicates when traders or investors establish a long or short position ... Read Answer >>
Hot Definitions
  1. Duration

    A measure of the sensitivity of the price (the value of principal) of a fixed-income investment to a change in interest rates. ...
  2. Dove

    An economic policy advisor who promotes monetary policies that involve the maintenance of low interest rates, believing that ...
  3. Cyclical Stock

    An equity security whose price is affected by ups and downs in the overall economy. Cyclical stocks typically relate to companies ...
  4. Front Running

    The unethical practice of a broker trading an equity based on information from the analyst department before his or her clients ...
  5. After-Hours Trading - AHT

    Trading after regular trading hours on the major exchanges. The increasing popularity of electronic communication networks ...
  6. Omnibus Account

    An account between two futures merchants (brokers). It involves the transaction of individual accounts which are combined ...
Trading Center