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Also called an underlier, an underlying security is the security upon which certain others (a call or put option, a convertible security, a stock option, a warrant, or stock right) are based. The underlying security must be delivered once the option, convertible, etc. is exercised. Futures and index options are exceptions to this rule, as they do not have an underlying security behind them. Instead, they are settled in cash. For convertibles, the underlying security is in the form of common stock. When a bond or a preferred stock is converted to common stock, the underlying security is delivered to the new owner. Stock options, warrants, and stock rights also have an underlying security in the form of common stock.
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