Understanding Underlying Assets: How to Choose and some Basics

The underlying asset of options is essentially the “thing” for which options are used. For example, you have stocks you can buy or sell on a certain date for a set amount. Those stocks are the underlying assets in this particular trade where an option is being utilized. And since you can trade all sorts of things, underlying assets can come in all shapes and sizes, especially in binary options which is better know as binary options. Mainly though, at least in the US options market, underlying assets can be categorized into two: securities options and futures options. As their names suggest, securities options are basically underlying assets traded on securities exchanges, while futures options are involved in the futures market.

Choosing underlying assets

Since underlying assets can be anything that can be traded, it’s easy to overlook them and simply focus on the option instead. You should pay attention to underlying assets too because they help determine whether or not the option you’re interested in is worth pursuing. To help you get started on choosing the right underlying assets, consider the following:

  • Your area of expertise or interest. The most reliable way of choosing underlying assets is to the route you know best: your area of expertise. By working with underlying assets you have experience in, you’ll have that in-depth knowledge needed in analyzing the possibilities of a trade involving an underlying asset. Don’t have experience with underlying assets? Your next best option is to pick an underlying asset you are interested in and to brush up on the topic as much as you can. By continuously studying a certain underlying asset, in time, your area of interest will become your area of expertise.
  • Market conditions. You can also choose an underlying asset based on the kind of market you want to participate in. Markets vary and some are just more volatile than others. Currency options, for instance, are very notorious for their volatility, while indices generally move along in line with trends and don’t jump erratically unless the market is experiencing a very large disturbance. Typically, if you’re just starting out, it’s best that you work with less volatile markets first, allowing you to get a feel of what it’s like to be waist-deep in the water without drowning yourself. If you’re in it more for the challenge and excitement though, you’re more than free to take on a volatile market right at the very beginning. Still, don’t forget to prepare a handful of trading strategies and to make sure that they are particularly suited for the market you’re interested in.
  • Major news events. Dozens of things happen every day that can greatly impact a market you’re trading in. To ensure you don’t get swept away by imbalances that will crop up, choose an underlying asset while factoring in major events. This will allow you to work around imbalances and make the most out of a situation you have no control of. If you can’t avoid taking a hit, the least you can do is to soften the blow, right? Focusing on major news events though will have you paying attention to a few potential assets in a day. This can be considered somewhat of a downside because you’ll be missing out on other underlying assets as you figure out how to move with those most affected by major news events.

A quick reminder

Trading may seem impersonal but it reflects many of the characteristics you have. It would help you decide then on how to trade with an underlying asset by taking note of what you believe are important. Working with an underlying asset you can relate to will help you become more invested in trading so you can better appreciate the rewards when they come.

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