What is the difference between underlying and instrument?

The difference between ‘underlying’ and ‘instrument’ lies in their specific roles within financial markets.

‘Underlying’ refers to the primary asset on which the value of a derivative contract is based. This asset can vary widely and includes stocks, commodities, market indices, or interest rates. The derivative’s value fluctuates based on changes in the underlying asset’s price or performance. For instance, in options trading, the underlying asset could be a specific stock or commodity upon which the option’s value is dependent.

‘Instrument’, on the other hand, is a broader term encompassing all tradable financial assets within the markets. It includes a wide array of assets such as stocks, bonds, currencies, commodities, and derivatives themselves. While an underlying asset is specifically tied to derivative contracts, instruments encompass a more comprehensive range of financial assets available for trading or investment purposes.

In essence, the ‘underlying’ asset acts as the foundation for derivative pricing and value determination, while an ‘instrument’ refers to any financial asset that can be traded in the markets, encompassing derivatives and a broader spectrum of assets.

Understanding this difference is crucial for investors and traders to effectively navigate and comprehend the various assets available for investment or trading purposes within the financial markets.