Underlying asset: meaning and examples

What is an underlying asset?

An underlying asset is the asset, price or rate that a derivative is based on. The derivative's value changes when the underlying changes.

A derivative is a contract whose value comes from something else. Options, futures, forwards and CFDs (contracts for difference) are all derivatives. The "something else" is the underlying.

Formal definition

In formal terms, the underlying is the reference variable named in the contract. The contract's payoff is calculated from it. It can be:

• a tradable asset, such as a share, a currency, gold or oil
• a price level that cannot be bought directly, such as a stock index
• a rate or a statistic, such as an interest rate or a volatility index
• another derivative, for example a futures contract that sits under an option on futures

The underlying does not have to change hands. Many contracts are cash-settled: only the price difference is paid. See cash vs physical settlement.

Underlying asset example

Take a hypothetical gold CFD with the symbol XAUUSD. The underlying is the price of gold quoted in US dollars. You do not own any gold. You hold a contract that pays or charges the difference between your opening and closing price.

The result is calculated like this:

profit or loss = price change × contract size × number of lots

If the gold price rises after a buy position is opened, the position gains. If it falls, the position loses by the same formula. To try real figures, use the tools on the calculators page.

Leverage means a small price move in the underlying can cause a large change in your account. Leveraged CFD and forex trading can lose money fast.

Underlying asset in options

For an option, the underlying is what the holder has the right to buy or sell. A call option on a share gives the right to buy that share at the strike price before or on the expiry date. The option's price depends on the underlying's price, its volatility and the time left. Delta measures how much the option price moves for a small move in the underlying.

Where you see the term

• Trading platforms: contract specifications in MT4 or MT5 show the symbol, contract size and trading hours. These describe the underlying the CFD tracks.
• Product documents: documents for an exchange-traded product or an ETN name the underlying index or asset.
• News: reports often say a futures or options price "tracks the underlying index", or that an option moved "with the underlying".

Edge cases for experienced traders

• Index CFDs: NAS100 or US100 track an index, which is a calculated number and not an asset you can buy. Some index CFDs are priced from futures, so a futures roll can affect them.
• Currency pairs: the underlying is an exchange rate between two currencies, not a single asset. See currency pairs.
• Derived prices: a CFD price is set by the provider and can differ slightly from the exchange price of the underlying, especially outside the exchange's hours.
• Depositary receipts: an ADR or GDR represents underlying shares held by a custodian.

Before trading any derivative in Pakistan, read Regulation and Safety.

Related terms

• Derivatives
• Forward contract
• Front month
• Contango and backwardation
• Commodity
• Exposure
• Trading glossary

Frequent questions

What is the underlying asset meaning in simple words?

It is the thing a derivative's price follows, such as a share, gold, an index or a currency pair.

Do I own the underlying asset when I trade a CFD?

No. A CFD only pays or charges the price difference. You do not hold the asset itself.

Can an index be an underlying asset?

Yes. An index cannot be bought directly, but futures, options and CFDs can use it as their reference price.

What is the underlying asset in options?

It is the asset the option gives the right to buy (call) or sell (put) at the strike price.

Does the derivative always move exactly with the underlying?

Not always. Options change by their delta. CFDs and futures can differ because of financing costs, rolls and quoting hours.