Is the approach that assumes derivative instruments can replicate the underlying security, basket of securities, currency, commodity or index. For example, see Synthetic Long and Synthetic Short. It is mostly true but important exceptions occur. For example, there can be differences in final returns due to tax considerations, possible extra transaction costs, and derivative securities do not include the shareholder vote. At times, such as proxy fights or other important issues, the replicated long position would have to be exercised into the actual security in order to be a timely shareholder of record. Expressed differently, increases in synthetic long positions do not increase the total number of votes or the total monetary amount of actual cash dividends.
to replicate the payout of an option by buying or selling other instruments. In the case of dynamic replication, this involves dynamically buying or selling the underlying (or futures, where transaction costs are cheaper) in proportion to an optionâ€(tm)s delta. In the case of static replication, the option is hedged with a basket of standard options whose composition does not change with time.