Underlying definition

Underlying is most used when talking about derivatives contracts, which are often structured around another asset. Derivatives contracts are trades built around the speculation of another asset’s price. The asset at the focus of a derivative contract is known as the underlying asset.

Underlying assets can be stocks or commodities in an options trade, the most common type of derivative, or they can be a financial metric such as a benchmark index or interest rate.

Understanding the underlying asset or index is crucial when trading a derivative. By speculating on the underlying asset with a derivatives contract, traders have more options such as shorting the asset’s price. However, derivatives are more volatile than simply trading their underlying assets. The value of a call or put option, two derivatives that often have stocks as the underlying asset, can fall to zero as the expiry date nears. Stock prices meanwhile are less likely to completely lose all value.