An underlying asset is the financial instrument or asset that is the subject of a derivative contract. A derivative is a financial contract whose value is based on the price of an underlying asset. Examples of underlying assets include stocks, bonds, commodities, currencies, and indices.
The price of the underlying asset is used to determine the value of the derivative contract. For example, in the case of a stock option, the underlying asset would be the stock on which the option is based. The price of the stock would be used to determine the value of the option. If the stock price increases, the option will typically increase in value as well.
It is also used to determine the expiration date, strike price, and other terms of the derivative contract. For example, in the case of a stock option, the underlying asset would determine the expiration date of the option, which would typically be the third Friday of the month.
It’s important to note that underlying assets can be both tangible and intangible assets like real estate, currencies, bonds, commodities, stock, and even weather patterns.
The underlying asset is a critical aspect of derivatives trading, as it is the underlying asset that gives the derivative its value. Understanding the this is essential for investors to make informed decisions when trading derivatives. It’s important to research the underlying asset, including its historical performance and the industry in which it operates, before investing in any derivative contract.
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