An underlying asset is an item of value which serves as the basis for speculative financial instruments which do not have any value in themselves (derivatives). Unlike derivatives, which are simply contracts, underlying assets must have intrinsic value. This means they must be either goods or services which perform a material function, title deeds to ownership of assets, or claims to interest payment or debt repayments. Cash, Shares, real estate, commodities, precious metals, bonds, cryptocurrencies and blockchain tokens are just some of the assets which can be used as underlying assets.
In a contract for difference (CFD), for example, the underlying asset of the CFD is the asset on which it is based. The CFD in itself does not have any intrinsic value. It is simply a contract between two parties in which each party agrees to pay the other party the difference between the current value and the future value of an underlying asset depending on whether its value increases or decreases. When you enter into a contract for difference you do not buy the underlying asset, you simply bet on its performance.
In an option, the underlying asset is the asset which the option gives you the right to buy at the strike price when the option matures. Options which are in the money have intrinsic value because they represent a direct claim to underlying assets. The difference between the (lower) strike price and the (higher) market price makes up the option’s intrinsic value.
The underlying assets of a future contract are the assets which the holder of the future contract is entitled to buy or sell to the other party to the contract when the future matures if the conditions of the contract are met.
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