Value Of An Underlier

So what are the most common underliers, by the way underlier is the thing which is used to derive the value of a derivative. It is that thing which can be sold or bought in a spot market at some future date at a predetermined price.

Therefore a simple underlier can be a commodity like wheat, or a financial security such as a share of stock. Theoretically in today’s market any traded item can become an underlier, but things that become good derivative underlier must to be both fungible and liquid. Fungible here means one is as good as the other, like barrel of oil and Dollar bills and liquid means there are large number of buyers at any given point in time. There are many which falls into the above category but vast majority of them fall into

They include grains such as corn and wheat, meats such as live lamb, chicken, pork bellies, and other foods such as coffee, sugar. Commodities also include metal such as gold and copper, and energy goods such as crude oil and natural gas. Commodities tend to be wholesale goods intended for manufacturers and service providers, rather than for consumers like you and me. Most commodity derivate are ETD at places like CBOT and the NYMEX

Currency: Currency meets the criteria for a good underlier. The currency market, aka foreign exchange (FX) market is the world’s largest spot market of any kind. On any given day more than a trillion units of currency are bought and sold with the prices of each note changing almost continuously. Currency is also a popular underlier for all sorts of derivatives, both OTC and ETD.

Money: this is bought and sold when it is borrowed or lent in the form of loads or bonds, when a government or corporation issues a bond, it is simply borrowing money. The price of money to an issuer is, of course, interest, which it pays to the bond holders (lenders). The market for this is known as the fixed income market from the days when all bonds paid a fixed rate of interest to its holders. There is a massive market for interest rate derivatives, the most common being interest rate swap in the OTC market and a variety of futures in the exchange

One of the best known indexes of all is the Dow Jones Industrial Average in the United States. The Dow is a weighted average of 30 individual stock price, it may not sound like an average price being in the thousands of dollars when most stocks trade for under a hundred. It’s so large because it is adjusted to account for corporate actions such as stock splits, where one share of stock is divided into two or more shares. Therefore Dow is just an average stock price which cannot be bought or sold in a spot market. The fact of the matter is that we cannot sell something in future which we cannot buy today in the spot market, which makes it interesting, as you cannot have a contract on something which you cannot buy or sell at a future date. This just means that when time comes for the underlier to be sold, the parties don’t literally sell the underlier but actually figure out the cash value of the derivative position and exchange the cash. By the Cash settlement can be and is being applied for about any