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Underlying Asset

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.

Explaining '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.

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.

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.


Further Reading


The economics of structured finance
www.aeaweb.org [PDF]
… of the prioritization scheme used in structuring claims, many of the manufactured tranches are far safer than the average asset in the underlying pool. This ability of structured finance to repackage risks and to create “safe” assets from otherwise risky collateral led to a dramatic …

Option pricing when the underlying asset earns a below-equilibrium rate of return: A noteOption pricing when the underlying asset earns a below-equilibrium rate of return: A note
www.jstor.org [PDF]
… of the prioritization scheme used in structuring claims, many of the manufactured tranches are far safer than the average asset in the underlying pool. This ability of structured finance to repackage risks and to create “safe” assets from otherwise risky collateral led to a dramatic …

The effect of derivatives trading on volatility of the underlying asset: evidence from the Greek stock marketThe effect of derivatives trading on volatility of the underlying asset: evidence from the Greek stock market
www.tandfonline.com [PDF]
… of the prioritization scheme used in structuring claims, many of the manufactured tranches are far safer than the average asset in the underlying pool. This ability of structured finance to repackage risks and to create “safe” assets from otherwise risky collateral led to a dramatic …

Statistical models for financial volatilityStatistical models for financial volatility
www.tandfonline.com [PDF]
… of the prioritization scheme used in structuring claims, many of the manufactured tranches are far safer than the average asset in the underlying pool. This ability of structured finance to repackage risks and to create “safe” assets from otherwise risky collateral led to a dramatic …

The impact of futures trading on volatility of the underlying asset in the Turkish stock marketThe impact of futures trading on volatility of the underlying asset in the Turkish stock market
www.sciencedirect.com [PDF]
… of the prioritization scheme used in structuring claims, many of the manufactured tranches are far safer than the average asset in the underlying pool. This ability of structured finance to repackage risks and to create “safe” assets from otherwise risky collateral led to a dramatic …

The financial crisis and the systemic failure of the economics professionThe financial crisis and the systemic failure of the economics profession
www.tandfonline.com [PDF]
… of the prioritization scheme used in structuring claims, many of the manufactured tranches are far safer than the average asset in the underlying pool. This ability of structured finance to repackage risks and to create “safe” assets from otherwise risky collateral led to a dramatic …

Understanding mechanisms underlying peer effects: Evidence from a field experiment on financial decisionsUnderstanding mechanisms underlying peer effects: Evidence from a field experiment on financial decisions
onlinelibrary.wiley.com [PDF]
… of the prioritization scheme used in structuring claims, many of the manufactured tranches are far safer than the average asset in the underlying pool. This ability of structured finance to repackage risks and to create “safe” assets from otherwise risky collateral led to a dramatic …

Do option markets correctly price the probabilities of movement of the underlying asset?Do option markets correctly price the probabilities of movement of the underlying asset?
www.sciencedirect.com [PDF]
… of the prioritization scheme used in structuring claims, many of the manufactured tranches are far safer than the average asset in the underlying pool. This ability of structured finance to repackage risks and to create “safe” assets from otherwise risky collateral led to a dramatic …

Tranching, CDS, and asset prices: How financial innovation can cause bubbles and crashesTranching, CDS, and asset prices: How financial innovation can cause bubbles and crashes
www.aeaweb.org [PDF]
… of the prioritization scheme used in structuring claims, many of the manufactured tranches are far safer than the average asset in the underlying pool. This ability of structured finance to repackage risks and to create “safe” assets from otherwise risky collateral led to a dramatic …



Q&A About Underlying Asset


Why would someone use a derivative contract such as an option rather than buying stocks directly?

Using derivatives allows investors to take advantage of market fluctuations without taking all of the risk associated with owning stocks directly."

How do derivatives work?

A derivative works by allowing investors to trade in or out of assets without having to own them outright. For example, if you want to buy stock in Company X but don't have enough money right now, you can purchase an option for 100 shares at $10 per share instead. If the stock goes up to $15 per share before your option expires, you can exercise your option and buy 100 shares at $10 each ($1,000 total). If the stock falls below $10 per share before your option expires, you can let it expire worthless and not have lost any money on the transaction because you didn't actually buy any shares. This allows investors to take advantage of market fluctuations without taking all of the risk associated with owning stocks directly. Derivatives also allow traders to hedge their positions against potential losses due to changes in prices or interest rates by using options contracts or futures contracts as hedging tools.""

Which type(s) will we be focusing on ?

We will be focusing on call options .

What does the term "derivative" mean?

A derivative is a financial instrument with a price that is based on (that is, derived from) another asset.

What is an underlying asset?

An underlying asset is a financial instrument on which a derivative's price is based.

What are some examples of derivatives?

Some examples of derivatives include options, futures and swaps.

Are there different types of derivatives?

Yes , there are different types .