Underlying asset

An underlying asset is that financial asset on which financial contracts fall, that is, the reference value of certain financial derivatives.

As we know, in finance there are products such as futures, options, warrants, swaps and other products that are not assets by themselves, but depend on the quotation, evolution and price of another specific asset. This asset is called the underlying asset.

The underlying asset is the source from which the value of financial contracts (instruments) is derived.

Example of underlying asset

Let's imagine that we have a neighbor who has a corn plantation. We need that corn for our farm, so we decided to reach an agreement with it.

For this, we agreed with him a future price on the harvest, valued at € 1,100 (currently that same harvest is worth € 1,000), which gives us the right to acquire it in six months at the agreed price.

The underlying asset would be corn, while the derivative contract would be the agreement we have reached with the neighbor. With this purchase option, we can sell it to a third party at the price we want, paying attention to the fact that the corn may be more expensive within six months, or perhaps cheaper.

Some of the instruments that work with this type of asset are options and futures. These instruments allow the holder to buy or sell a certain asset (underlying) at a certain time at a previously agreed price.

These instruments can be used as hedging (protection) against variations in the market, or simply as speculation and / or investment.

Other examples are the assets on which investment funds work. When a fund returns on a stock index, commodity or real estate business, those assets are called base assets or underlying assets.