What It Is:
An underlying asset is a security on which a derivative is based.
How It Works/Example:
For example, options are call option on of Intel (INTC) with a strike price of $40 and an expiration date of April 16. This would give you the right to purchase 100 of Intel at a price of $40 on April 16 (the right to do this, of course, be valuable only if Intel is trading above $40 per at that point in time).instruments, meaning that their prices are derived from the price of another security. More specifically, options prices are derived from the price of an underlying . For example, let's say you purchase a
The seller (writer) has the ) to the buyer at a specified price by a specified date. Meanwhile, the buyer of an options contract has the right, but not the , to complete the transaction by a specified date. When an expires, if it is not in the buyer's best interest to exercise the , then he or she is not obligated to do anything. The buyer has purchased the to carry out a certain transaction in the future -- hence the name.to either buy or sell the underlying (depending on what type of he or she sold -- either a or a
Why It Matters:
Investors use options and the concept of underlying assets for two primary reasons -- to speculate and torisk. When you purchase options to speculate on future price movements, you are limiting your , yet your potential is unlimited.