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The world of investing is a diverse one. Investors can choose to directly own assets, such as bonds, stocks, crypto, etc. On the other hand, they can invest in financial derivatives and funds, the performance of which depends on the asset they are tracking.
This is called the underlying asset and is a cornerstone of some of the most complex financial instruments available on the market.
From equity instruments, such as ETFs and REITs, to financial derivatives, such as options and futures contracts, the underlying asset can be anything investors can otherwise directly access and own themselves.
For example, ETFs tracking the performance of the S&P 500 are some of the most popular investment vehicles on the equities market. The underlying asset of these funds is the S&P 500 index itself, which is a basket of some of the largest listed equities in the United States and the world.
An underlying asset can be anything that can be tracked and that creates a derivatives market around it. Investors and traders tend to speculate on the price of an asset without wanting the burden of owning the asset itself.
The various types of underlying assets include:
The price movements in the underlying asset are what determine the performance of the derivative. For this reason, underlying asset prices are the single most important factors on any financial market.
However, depending on the type of derivative, the degree of influence of the underlying asset can vary.
An underlying asset serves as the basis for derivative contracts in trading. Its price movements directly affect the value and performance of derivatives. Traders use derivatives to speculate on or hedge against changes in the underlying asset's price or other characteristics.
Examples of underlying assets in trading include stocks (for stock options and futures), bonds (for bond futures), currencies (for forex contracts), commodities (such as gold, oil, and agricultural products), indices (like the S&P 500), interest rates, and cryptocurrencies like Bitcoin.
Some underlying assets, like individual stocks or cryptocurrencies, can be highly volatile, experiencing frequent and significant price fluctuations. Others, such as government bonds or stable currencies, tend to be less volatile and more stable in value.