Underlying Asset

An underlying asset is the financial asset on which a derivative contract, such as an option, futures contract, or swap, is based. The value of the derivative depends on the price movements of the underlying asset, which can include stocks, bonds, commodities, currencies, or market indices. Derivatives allow traders to speculate on or hedge against price changes in the underlying asset without directly owning it.

Example

In a stock option contract, the underlying asset is the stock of a particular company. The value of the option rises or falls based on the stock’s price movements.

Key points

• The financial asset on which a derivative contract is based.

• Can include stocks, bonds, commodities, currencies, or indices.

• The value of the derivative is derived from the price movements of the underlying asset.

Quick Answers to Curious Questions

Why is the underlying asset important in derivative trading?

It determines the value and performance of the derivative, as the price of the derivative is directly linked to the movements of the underlying asset.

What types of financial instruments can serve as underlying assets?

Underlying assets can include stocks, bonds, commodities, currencies, or even market indices.

How do investors use derivatives based on underlying assets?

Investors use derivatives to hedge against price fluctuations, speculate on future price movements, or gain exposure to an asset without directly owning it.