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What is an underlying asset?

April 26, 2017ASSET underlying

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What is an underlying asset?

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10 Posted

Suppose you hold a call option to purchase IBM stock in three months. The value of this contract depends on the value of IBM stock, the underlying asset. Underlying assets for a real option are similar, they are traded securities in the financial market whose fluctuations largely determine the value of the option. For example, the underlying asset for oil exploration is the appropriate oil futures contract or index of contracts. Traded contracts price in teh convenience yield while spot prices do not include the value of this attribute. Note that product prices (such as the spot price of oil) or cashflows (such as profits) are not assets. Framing must include the transformation of these cashflows to uncertain assets.