What It Means
The underlying asset is the actual stock, index, or commodity that a derivative contract — a future or an option — derives its value from. A Reliance call option's underlying asset is Reliance stock; a Nifty future's underlying asset is the Nifty 50 index.
How It Works
A derivative has no independent value of its own — its price moves in response to what the underlying is doing, filtered through mechanics specific to the contract type (strike price and time to expiry for options, cost of carry for futures). This is exactly why derivatives are called derivatives: their price is derived from something else. Understanding what the underlying is doing, and why, is the foundation for trading any F&O contract built on top of it — a trader who watches option premiums without tracking the underlying is missing the actual driver of the price they're trading.