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An underlier is a commodity or some form of security that provides the backing for the trading of shares. Sometimes referred to as an underlying security, the underlier is the security that may be called for delivery in the event that an option associated with the transaction is called or exercised. Generally, the underlier can also be a security that cannot be delivered, but will be settled with cash.
The use of underliers in most forms of investments is essential in order for trades to take place. Because the underlier involves securities and commodities that will in effect guarantee the current base trading value of the investment, the stability of the instrument used as an underlier must be affirmed. Without a stable underlying security, shares of stock become worthless and the investor will quickly lose money on the investment.
While most examples of the underlier will include instruments that can be delivered when an option is exercised, there are a few exceptions to this rule. Index options are one example of an underlier that cannot be delivered. Futures options are also often employed as an underlier. However, it is important to note that in both of these options, they remain a stable underlying security, and the investor who chooses to exercise the option will receive a settlement in cash.
Depending on the market and the nature of the investment opportunity, the shares issued by a company may be backed by more than one underlier. However, it is more common that a single type of underlier is employed. This is considered to be a more favorable situation for most investors, since the use of a single type of underlying security is thought to be less subject to shifts in value. From a practical point of view, a single type of underlier is also easier to monitor than multiple securities or commodities.
This does not mean that stocks that utilize more than one underlier should be avoided at all costs. In fact, there are examples of shares supported by multiple securities that perform very well. In any case, the investor should look into the status of the underlier and be comfortable with the degree of stability present before choosing to purchase any shares.
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