Underlying asset are the economic assets from which a derivative’s price is derived.
An example of a derivatives would be Options.
A derivative can be defined as an economic instrument with a value that is derived from another asset.
Underlying assets provide value to derivatives.
For instance, an option on security ABC provides the option holder the right to purchase or sell ABC at the strike price before option expiry.
Here, the security of ABC acts as the underlying asset for the option contract.
An underlying asset can be utilized to recognize the thing inside the agreement that gives value to the derivative contract.
The underlying security supports the stock involved in the contract, which the people involved accept to trade as part of the option contract.
The value of an option or futures contract is obtained from the price of an underlying security.
In an derivative contract, the writer must either purchase or sell the underlying security to the purchaser on the determined date at the settled upon price.
The purchaser is not obligated to buy the underlying security, yet they can practice their right if they decide to do so.
If the option is going to expire, and the underlying security has not moved well enough to make practicing the option advantageous, the purchaser can let the contract expire and they will lose the premium they paid for the option contract.