Investing Assets & Markets What Is an Underlying Asset? Underlying Assets Explained in Less Than 4 Minutes By Dan Marticio Dan Marticio Website Dan Marticio is a trusted personal finance writer whose articles and reviews about loans, investing, and small business have appeared on top financial sites including The Balance, LendingTree, ValuePenguin, Fundera, and NerdWallet. learn about our editorial policies Updated on January 17, 2022 Reviewed by Thomas J. Brock Reviewed by Thomas J. Brock Thomas J. Brock is a CFA and CPA with more than 20 years of experience in various areas including investing, insurance portfolio management, finance and accounting, personal investment and financial planning advice, and development of educational materials about life insurance and annuities. learn about our financial review board Fact checked by Gina LaGuardia Fact checked by Gina LaGuardia Twitter Gina LaGuardia has more than 25 years of experience in senior editorial roles, and is an expert in personal finance topics, including banking and lending. She has created content for financial powerhouses such as Chase Bank, American Express Canada, First Horizon Bank, BBVA, and SoFi. learn about our editorial policies Share Tweet Pin Email In This Article View All In This Article Definition and Examples of an Underlying Asset How Does an Underlying Asset Work? What It Means for Individual Investors Definition An underlying asset is an asset that influences the performance or value of a derivative security. They include stocks, bonds, interest rates, and currencies. Photo: Westend61 / Getty Images An underlying asset is an asset that influences the performance or value of a derivative security. They include stocks, bonds, interest rates, and currencies. Learn about underlying assets, how they work, and what they can do for you as an investor. Definition and Examples of an Underlying Asset Underlying assets are the assets that influence the value of a derivative security. In other words, derivatives “derive” their value from their underlying asset. Alternate name: Underlier, underlying, underlying interest, underlying security In the case of stock options, the underlying asset is the stock itself. Let’s say you purchase a call option at the $100 strike price for Company XYZ. The underlying asset is the stock valued at $100. This call option gives you the right to buy the equity at $100 by the deadline. If the stock is trading at $110 before the deadline, you can execute your right to purchase it at $100—the value of the underlying asset. How Does an Underlying Asset Work? There is a direct relationship between a derivative and its underlying security. “The price movements of a derivative security are directly related to the price movements of the underlying asset,” Dr. Robert R. Johnson, a finance professor at Creighton University’s Heider College of Business told The Balance in an email. “That is, the buyer of a call option on Tesla stock gains when the value of Tesla stock rises and loses when the value of Tesla stock falls.” Note The range of possible underlying assets is wide. Stocks and bonds are common examples. An underlying asset can also be foreign currencies, gold, wheat, cryptocurrencies, or even pork bellies, according to Johnson. Some investors that trade derivatives use futures contracts to mitigate risk. A futures contract allows the investor to lock in a price for, say, a commodity like corn, by a specified deadline. The value of the contract is based on the underlying asset: corn. Johnson provided an example of how this concept might work for a farmer. “A farmer who grows corn has a natural long position in corn,” Johnson said. “That farmer may want to lock in a price for [their] corn at harvest instead of simply waiting and seeing what the market price will be at the time [the farmer] harvests the corn. In that case, the farmer might sell corn in the futures market, guaranteeing the price [they] will receive.”Whether the future price is higher or lower than the locked-in price determines the profit or loss for the farmer. “If at the time of harvest the price of corn is lower than that at which [the farmer] contracted to sell, [they] would have won by selling the futures contract,” he said. “If the price is higher, [they] would have been better off not selling corn futures and [getting the] higher market price.” What It Means for Individual Investors Understanding underlying assets is critical to investors who want to engage in derivatives trading, whether it be options contracts or futures contracts. Derivatives trading isn’t easy and the losses can be substantial, so they aren’t recommended for beginning investors. Note Investors that trade security futures contracts should be wary of the risk. Because futures trading tends to be highly leveraged, you can lose a tremendous amount of money in short periods of time. “The quality of the derivatives market that is attractive—and also dangerous—to investors is that derivatives markets allow investors to leverage their positions,” Johnson said. “Investors can use margin to control a larger pool of assets with a smaller amount of money. In the stock market, investors can control $100,000 worth of securities with $50,000.” But what makes the derivatives market attractive to investors comfortable with risk is the increased leverage they achieve, Johnson said. “In the derivative markets, the leverage factor is much higher,” he said. “For instance, in the foreign exchange markets, leverage is commonly as high as 100 to 1. That is, you can control up to $100 in foreign currency for every dollar of equity in your account.” Understanding how the markets will shift will affect your profitability in the derivatives market. “Leverage is terrific when markets move in the direction you anticipate,” Johnson said. “ But, if markets move against you, with leverage, you can lose money very quickly.” Key Takeaways Underlying assets are the assets that influence the value of a derivative security.The rise and fall of a derivative security’s value typically correlate with the rise and fall of the value of its underlying asset.Examples of underlying assets include stocks, gold, cryptocurrencies, and wheat.When investing in the derivatives market, an understanding of how market conditions will influence the value of underlying assets is crucial. Was this page helpful? Thanks for your feedback! Tell us why! Other Submit Sources The Balance uses only high-quality sources, including peer-reviewed studies, to support the facts within our articles. Read our editorial process to learn more about how we fact-check and keep our content accurate, reliable, and trustworthy. National Futures Association. "Interpretive Notices: 9050 - NFA Compliance Rule 2-30(b): Risk Disclosure Statement for Security Futures Contracts." Accessed Nov. 15, 2021.