Glossary
Underlying asset
The stock, index, commodity, currency or other asset whose price determines the value of a derivative such as an option or futures contract.
On this page
The underlying asset, or simply the underlying, is the thing a derivative's value is based on. For an Apple call option it is Apple stock; for an S&P 500 futures contract it is the index; for a crude-oil future it is a set quantity of oil. Every derivative is, at heart, a contract about what the underlying will do, so understanding the underlying comes before understanding the contract.
How it works
A derivative's terms tie its payoff to the underlying's price at specific points. A standard US equity option covers 100 shares of the underlying stock. If exercised, a stock option is settled by delivering those shares; an index option, such as one on SPX, is settled in cash because an index cannot be delivered.
Other derivatives work the same way. A leveraged ETF is built from swaps and futures on an underlying index. A warrant is linked to the issuer's own stock. A credit default swap's underlying is a company's debt.
Why it matters
The underlying's characteristics carry straight through to the derivative. A volatile underlying makes options more expensive. Dividends paid by the underlying lower call values and raise put values. Events that halt or gap the underlying, such as an earnings release or a trading halt, hit the derivative too, usually with more force because of leverage. Corporate actions on the underlying, including splits, special dividends and mergers, can change the contract's terms, through adjustments set by the Options Clearing Corporation for listed options.