The underlying asset is the thing a derivative refers to. A call warrant on a share moves with that share. A futures contract on coffee refers to coffee. You may never hold the underlying itself, yet its price still drives the contract’s value.
Key takeaways
- Always identify the underlying before you trade any option, warrant, or future.
- Liquidity and news in the underlying flow through to pricing of related contracts.
- Some products settle in cash based on the underlying’s price rather than delivering the asset.
- Leverage in derivatives can magnify both gains and losses relative to moves in the underlying.