What is ‘the asset’
Assets include stocks, indices, bonds, interest rate, currency or commodity on which the derivative instruments such as futures and options based. It is the main component as a derivative derives its value.
For example, a call option on Google (similar to how googl) shares give the holder the right but not the obligation, to buy Google stock at the price specified in the contract. In this case the Google stock is the underlying security.
Breaking down the ‘asset’
There are many widely used and exotic derivatives, but they all have one thing in common that is the basis of the underlying security or underlying asset. Price movements of the asset will necessarily influence the pricing of derivatives, created on its basis.
In derivative terminology, the underlying security is often referred to simply as “basic.” The underlying security can be any asset, index, financial instrument or even another derivative. The infamous collateralized debt obligations (cdo) and credit default swaps (CDS) that were at the heart of the financial crisis of 2008 well as derivatives that depend on the movement of the underlying.
Traders use derivatives to either speculate or to hedge future price movement of the underlying. More complex derivative becomes more significant degree of speculation and hedging. For example, futures options betting on the future price of the futures contract, which in itself is a bet on the future price of the underlying asset.
The role of basic
The obvious role of the underlying asset only for themselves. If it were not for derivatives, traders just buy and sell the underlying. However, when it comes to derivatives, is the basic element that needs to be delivered by one party to derivative contracts and accepted by the other party. With the exception of cases when the underlying index, or derivative instrument is a swap, where only money at the end of the derivative contract.
The core is also important for pricing derivatives. The relationship between basic and its derivatives is not linear, although it can be. For example, a more distant strike price for-money option from the current price of the underlying asset, the less the possibility of changing the unit price to move in a major.
In addition, the derivative contract can be written so that its price can be directly connected, or Vice versa correlated with the price of the underlying asset. A call option is directly linked. The option has an inverse correlation.