An underlying share is the share of a specific company that is named in a derivative financial instrument such as an option or a future.
Exchange Traded Funds (ETF) and Underlying Shares
Underlying shares could also be the basket of shares that comprise one unit of an Exchange Traded Fund (ETF). A unit of an ETF could have one or more shares of companies that constitute a part of an index or a sector. These shares are the ‘underliers’ from which the unit of the ETF derives its price. The units of an ETF do not have a Net Asset Value (NAV). The market price of units of an ETF is determined by the market depending upon demand and supply but generally it would mirror the NAV of the underlying shares. This gives rise to the possibility of arbitrage between the actual shares and the ETF unit for which these shares are the underliers.
Advantages
The investor derives a dual benefit – the diversification and spreading of risk similar to that from investing in an index fund coupled with liquidity of a share that could be sold in the stock market. Additionally, an investor could make purchases in the secondary stock market or buy on margin or short sell units. These trades would, of course, attract payment of brokerage.
